1.3 - Putting a Business Idea into Practice

Question 1

What do businesses need to have to get what they want to achieve?

Answer 1

+Businesses need to have aims - overall goals that they want to achieve.

+They also need objectives, which are like mini aims.

+Aims and objectives can be financial or non-financial.

Question 2

How can financial aims be measured?

Answer 2

+Financial aims can be measured in terms of money

Financial aims include:

• Survival
• Maximise Profit
• Increase Market Share
• Maximise Sale
• Achieve Financial Security

Question 3

How is Survival a financial aim for a business?

Answer 3

+Around 60% of new firms close within five years of starting, so just surviving is the main and most important short-term aim of all new businesses.

+This means the business needs to have enough money to stay open, eg. to buy stock and pay staff.

Question 4

How is maximising profit a financial aim for a business?

Answer 4

+The vast majority of firms will aim to maximise profits.

+However, it may take a few years for a new firm to make any profit at all.

Question 5

How is increasing market share a financial aim for a business?

Answer 5

+Market share tells you what percentage of a market’s total sales a particular product or company has made.

+When a business first starts up it has zero market share… so one of its first aims is to capture a part of the market and establish itself.

+It can then aim to increase market share by taking sales away from competition, or by persuading new customers to enter the market and buy its products.

Question 6

How is maximising sales a financial aim for a business?

Answer 6

+Increasing sales is a good way for a business to grow its market share

+The business can monitor sales in terms of how many of a particular product it sells, or by how much money it takes from selling its products - this is not the same as maximising profit.

+Eg. a business might reduce prices in order to increase sales, but selling products more cheaply means it won’t make as much profit.

Question 7

How is achieving financial security a financial aim for a business?

Answer 7

+Many businesses will depend on external sources of finance such as loans or the business owners’ personal savings when they first start.

+So an aim for a new business is likely to be achieving a point where it can depend on its own revenue to fund its activities [ie. its sales go beyond its break even point].

Question 8

What other aims can there be for starting a business?

Answer 8

+There may also be non-financial aims for starting a business - many new businesses have aims that aren’t centred around money; These aims include:

• Accomplishing a personal challenge
• Achieving personal satisfaction
• Gaining independence and control
• Doing what’s right for society

Question 9

How is accomplishing a personal challenge a non-financial aim for starting a business?

Answer 9

+Some people want the challenge of setting up and running a new business.

+And if the risks pay off, there could be big rewards.

Question 10

How is achieving personal satisfaction a non-financial aim for starting a business?

Answer 10

+Some people want the satisfaction that comes with owning their own business, particularly if their company allows them to follow an interest.

+Eg. a history-lover might set up a tour company for a historical site.

+Being interested in what they do can give a person a lot of job satisfaction.

Question 11

How is gaining independance and control a non-financial aim for starting a business?

Answer 11

+Some people might want the independence of being their own boss.

+This means they have control over what they do each day, and make the decisions about how the business will be run.

+They might have flexible working hours, meaning it’s easier to fit work around other commitments, like childcare.

Question 12

How is doing what is right for society a non-financial aim for starting a business?

Answer 12

+Some firms want to make sure they are acting in ways that are best for society and that society beliefs that are morally right [eg. many consumers think it’s wrong to test cosmetics on animals].

Question 13

Why is having aims important for a business?

Answer 13

+Having aims is important for a business - Managers use aims to make decisions about how the business should be run.

+Also having aims means anyone interested in the business can easily work out what the business is all about.

Question 14

What are the drawbacks of aims?

Answer 14

+Aims can be pretty vague and overwhelming for a business.

+Luckily, objectives mean aims can be broken down into bitesized chunks - so suddenly things don’t seem so scary anymore.

Question 15

What do objectives help businesses with?

Answer 15

+Once a firm has established its aims, it needs to set business objectives

+Objectives help businesses achieve their aims.

Question 16

What are the different types of objectives?

Answer 16

+Just like with aims, there are different types of objectives

+They can be related to survival, profit, market share, sales, financial security, personal reasons or social issues.

Question 17

How are objectives more specific than aims?

Answer 17

+Objectives are more specific than aims - they’re measurable steps on the way to the aim.

+Eg. if a firm’s aim is to maximise sales, an objective might be to increase income from sales by 30% over two years.

Question 18

What can objectives act as once set?

Answer 18

+Once objectives have been set they act as clear targets for firms to work towards.

+They can later be used to measure whether a firm has been successful or not.

Question 19

Give an example of a business implementing business aims and objectives.

Answer 19

1. Cathy owns a bike hire business.
2. The business has a social aim to improve fitness of primary school children in the local area.
3. To achieve this aim, Cathy sets the following objectives:
   
   • To train volunteers to teach children how to ride a bike
   • To work with a local primary school to offer an after-school cycle club
   • To teach 30 children to ride a bike during the first school year of the project
   • To speak to her local councillor about setting up a cycle path in the local park
4. After a year, she can look back and see how well these objectives have been achieved - she can then adjust them if necessary in order to continue working towards her aim.

Question 20

What do not all companies have?

Answer 20

+Not all companies have the same aims and objectives - there are different factors that affect the aims and objectives of a business. Eg:

• The size and age of the business
• Who owns the business
• The level of competition the business faces

Question 21

How does size and age of the business affect its aims and objectives?

Question 22

How does who owns the business affect its aims and objectives?

Answer 22

+For small businesses that are owned by only one or a small number of people [eg. sole traders and partnerships], non-financial aims and objectives such as achieving personal satisfaction may be more important than growing sales or market share, especially when the business is still young.

+For companies that are owned by many shareholders [eg. private limited companies] there may be pressure to have aims and objectives focused on maximisiing profit so shareholders get more money.

Question 23

How does the level of competition the business faces affect the aims and objectives of a business?

Answer 23

+If a business is in a highly competitive market, it might focus on survival or maximising sales.

+If a firm doesn’t face much competition, its aims and objectives may be focused more on increasing market share and maximising profits.

Question 24

What is revenue?

Answer 24

+Revenue is the income earned by a business

+Businesses earn most of their income from selling their products to customers.

Question 25

How can revenue be calculated?

Answer 25

+Revenue can be calculated by multiplying quantity of units sold by the price [the amount the customer pays]

Question 26

What is the equation for revenue?

Answer 26

Revenue = Price x Quantity

Question 27

What are costs?

Answer 27

+Costs are the expenses paid out to run the business

Question 28

What are fixed costs?

Answer 28

+Fixed costs don’t vary with output [the amount a business produces].

+They have to be paid even if the firm produces nothing.

+Eg. the rent, insurance, fixed salaries for employees and advertising.

Question 29

What are variable costs?

Answer 29

+Variable costs are costs that will increase as the firm expands output.

+Eg. the costs of factory labour, raw materials and running machinery.

Question 30

What is the equation for total variable cost?

Answer 30

total variable cost = quantity sold x variable cost per unit

Question 31

What is the drawback of fixed costs?

Answer 31

+Fixed costs are only fixed over a short period of time - an expanding firm’s fixed costs will go up.

Question 32

What are total costs?

Answer 32

The total costs for a firm are the fixed and variable costs added together:

total costs = total fixed costs + total variable costs

Question 33

What is interest added to?

Answer 33

Loans and Savings

Question 34

What is interest?

Answer 34

+When a business borrows money, it will usually have to pay it back with interest - this is a charge for borrowing money - so the business will pay back more than was borrowed.

Question 35

How can interest be written?

Answer 35

Interest can be written as a percentage of the original amount borrowed.

Question 36

What is the equation for interest?

Answer 36

To find the amount of interest that a business has paid on a loan, just use the following equation:

interest [on loans] =

total repayment - borrowed amount x100 borrowed amount

Question 37

What is interest also added on?

Answer 37

+Interest is also added on savings - so a business can also earn money through interest on savings.

Question 38

How can you calculate the total repayment?

Answer 38

+You can calculate the total repayment by multiplying monthly repayment by the number of months the firm is taking to repay the loan.

Question 39

What do businesses make if they earn more than they spend?

Answer 39

+Businesses make a profit if they earn more than they spend

Question 40

What is profit?

Answer 40

+Profit [or loss] is the difference between revenue and costs over a period of time.

Question 41

What is the equation for profit?

Answer 41

Profit = revenue - costs

Question 42

What happens if costs are higher than revenue?

Answer 42

+If costs are higher than revenue, the business will make a loss instead of a profit, and the answer to the calculation will be negative.

Question 43

What does Break-even analysis allow?

Answer 43

Break even analysis allows firms to find out the minimum amount they need to sell to get by.

Question 44

What does Breaking Even mean?

Answer 44

Breaking even means covering your costs

Question 45

What is the break-even level of output?

Answer 45

+The break-even level of output or break-even point is the level of sales [or output] a firm needs in order to just cover its costs.

Question 46

How can the break even point be measured?

Answer 46

+It can be measured by the number of units a firm needs to sell to break-even.

+Or it can be measured by the revenue the firm needs to make to cover its costs.

Question 47

What is the equation for the break-even point in units?

Answer 47

break-even point in units = fixed cost sales price - variable cost_{[per unit]}

Question 48

What is the equation for the break-even point in revenue?

Answer 48

break-even point for revenue [or costs] = break-even point in units x sales price

Question 49

What happens if a firm sells more than the break-even point?

Answer 49

+If a firm sells more than the break-even point, it’ll make a profit - if it sells less, it’ll make a loss.

Question 50

What should new businesses always do?

Answer 50

+New businesses should always do a break-even analysis to find the break-even level of output.

Question 51

Give an example of a business doing break-even analysis?

Answer 51

• Pin-Chit Ltd. make Padlocks - They have fixed costs of £2000, and the variable cost per unit is £2. The selling price is £4.
• Their break-even output = 2000 ÷ [4-2] = 2000 ÷ 2 = 1000 units
• So the firm will break even if it makes and sells 1000 units
• The break-even point for revenue = 1000x4=£4000
• This means that the firm should have a revenue of £4000 in order to break even.

Question 52

What does a low break-even output mean?

Answer 52

+A low break-even output is good for a business as it wont have to sell as much to make a profit.

Question 53

What do break-even diagrams show?

Answer 53

+Break-even diagrams show the effect of output changing

Question 54

What does a break-even diagram have?

Answer 54

+A break-even diagram has number of sales or output on the x-axis, and costs and revenues on the y-axis.

Question 55

What does the difference between the total costs and the total revenue at any point on the graph?

Answer 55

This tells you the profit [or loss] a firm will make at that level of output.

Question 56

What does the total revenue do on a break-even graph?

Answer 56

The total revenue increases as more units are sold

Question 57

What does the total costs include on a break-even graph?

Answer 57

+The total cost includes both the fixed and variable costs

Question 58

What does the variable cost do on a break-even graph?

Answer 58

+The variable cost rises with output

Question 59

What does the fixed cost do on a break-even graph?

Answer 59

The fixed cost doesn’t change

Question 60

What happens on a break-even graph if the output is higher than the break-even output?

Answer 60

The firm will make a profit

Question 61

How do you find the break-even output on a break-even graph?

Answer 61

+To find the break even output, just find the point at which the line for total costs crosses the line for total revenue.

+Then draw a line down to the x-axis and read off the value.

Question 62

What happens on a break-even graph if the output is lower than the break-even output?

Answer 62

Then the firm will make a loss

Question 63

On a break-even graph, how do you find the break-even point for costs or revenue?

Answer 63

+Find the point at which the line for total costs crosses the line for total revenue.

+Then draw a line across to the y-axis and read off the value.

Question 64

What does the margin of safety do?

Answer 64

This is an easy way of seeing how much a business’s output can fall before it starts making a loss.

Question 65

What is the margin of safety?

Answer 65

+The margin of safety for a firm is the gap between the current level of output and the break-even output.

Question 66

What is the equation of the margin of safety?

Answer 66

margin of safety = actual sales [or budgeted sales] - break even sales

Question 67

What do firms often forecast?

Answer 67

+Firms forcast how much they are likely to sell in a given period of time.

+These predictions are often based on previous sales and their best guess.

Question 68

When will the firm use budgeted sales?

Answer 68

+The firm will use budgeted sales if it is trying to forecast its future margin of safety.

+The budgeted sales will be the sales it expects to make.

Question 69

What may revenue and costs do?

Answer 69

Revenue and costs may change

Question 70

What can break-even diagrams also be useful for?

Answer 70

+Break-even diagrams can also be useful for seeing how changes in revenue and costs may affect the break-even output.

+Eg. the rate at which revenue changes may decrease if the firm decides to lower its prices - The rate at which costs change may also increase or decrease, eg. if the cost of supplies changes.

Question 71

What is cash-flow not the same thing as?

Answer 71

Profit

Question 72

What is cash?

Answer 72

+Cash is the money a company can spend immediately.

+A business needs cash in order to pay its employees, its suppliers and overheads [these are ongoing expenses, eg. rent or lighting].

Question 73

What is profit the amount of?

Answer 73

+Profit is the amount of money a company earns after costs have been taken into account

+So a business can make a profit if it earns more than it spends but still run out of cash if it uses its cash to invest in other assets for the business.

Question 74

What are assets?

Answer 74

+Assets are valuable items owned by the business [eg. equipment, buildings], or money owed to the business.

Question 75

What is cash flow?

Answer 75

+Cash flow is the flow of all money into and out of the business.

+When a firm sells its products, money flows in [cash inflow]

+When it buys materials or pays wages, money flows out [cash outflow].

Question 76

What is the equation for net cash flow?

Answer 76

Net cash flow = cash inflows - cash outflows for a given period of time

Question 77

What happens if a company has a positive cash flow?

Answer 77

+If a company has positive cash flow, then there is more cash inflow than cash outflow for a particular time period.

+Positive cash flow means that a company has no problem in making payments.

+However, it may also mean that the company is losing opportunities to invest in ways that might improve it [eg. in new equipment].

+Positive cash flow is not the same thing as profit though - a company may make a profit if overall it earns more than it spends, but still have a poor cash flow [eg. if cash inflow does not occur in time to make cash outflow requirements].

Question 78

What do cash-flow forcasts help?

Answer 78

Cash flow forcasts help firms to anticipate problems

Question 79

What is a cash-flow forecast?

Answer 79

+A cash flow forcast lists all the inflows and outflows of cash that appear in the budget [a forecast of all of the firm’s likely expenses and revenue].

+It can be used to show when the firm may face a lack of cash - a lack of cash could lead to the firm failing, because it may be unable to pay its debts [insolvency], unless it sells off its assets.

+The firm can use the forecast to determine when it will need a short term source of finance to covers its costs.

Question 80

What is the equation of closing balance?

Answer 80

closing balance = opening balance + net cash flow

Question 81

When will a firm’s cash flow change?

Answer 81

+A firm’s cash flow will change if they give their customers longer to pay for products - this is called credit.

Question 82

What can credit terms affect?

Answer 82

Credit terms can affect cash flow

Question 83

What do credit terms tell you?

Answer 83

+Credit terms tell you how long after agreeing to buy a product the customer has to pay.

+This can affect the timings of a business’s cash flows.

Question 84

Why do firms need finance?

Answer 84

+Firms need finance for five reasons:

• New firms need start up capital [the money or assets needed to set up a business].
• New firms often have poor initial cash flow - this means that they find it hard to cover their costs, so they need additional finance to cover this.
• Sometimes customers delay payment, so finance is needed to cover this shortfall in [lack of] cash.
• If a business is struggling, it may need additional finance to meet its day-to-day running costs.
• Firms may need finance in order to expand [eg. to buy larger premises]

Question 85

What do small firms have?

Answer 85

Several sources of start up finance?

Question 86

What are short-term sources of finance?

Answer 86

These will lend money for a limited period of time

+Eg:

• Trade-credit
• Overdrafts

Question 87

How is trade credit a short term source of finance for small firms?

Answer 87

+Businesses may give firms one or two months to pay for certain purchases - this is useful for a small firm as they have time to earn the money needed to pay the debt.

+However, if the firm makes the payment too late, they could end up with a large fee.

+Paying off the debt will increase the firm’s costs, especially if there’s a fee, so it will need to make sure that it can cover these costs.

Question 88

How are overdrafts a short term source of finance for small firms?

Answer 88

+Overdrafts let the firm take more money out of its bank account than it it has paid into it.

+Overdrafts can allow businesses to make payments on time even if they don’t have enough cash.

+However, they usually have a higher interest rate than other loans and the bank can cancel any time - If it isn’t paid off, then the bank can take some of the business’s assets.

Question 89

What are long-term sources of finance?

Answer 89

+Long-term sources can either be paid back over a longer period of time - usually more than a year, or don’t need to be paid back at all.

+These sources include:

• Loans
• Personal Savings
• Share Capital
• Venture Capital
• Retained Profit
• Crowd Funding

Question 90

How are Loans a long term source of finance for small businesses?

Answer 90

+Loan [loan capital] - eg. bank loans are quick and easy to take out.

+Like overdrafts, they are repaid with interest and if they aren’t repaid, the bank can repossess the firm’s assets.

+However, the interest rate for loans is usually lower than for overdrafts - the business may have to pay the loan back in monthly installments, which will increase their fixed costs.

+Before taking out the loan, the business should check that they can still break even with this increase in costs.

Question 91

How are pesonal savings a long term source of finance for small businesses?

Answer 91

+A business owner may put some of their own money into the business to get it started or if it is having cash flow problems.

+However, this is risky as the owner could end up losing their money if the business fails.

Question 92

How is share capital a long term source of finance for small businesses?

Answer 92

+Individuals can buy shares in the business - This means that they will have have part ownership in the business and the business can use the money gained through issuing shares.

Question 93

How is venture capital a long term source of finance for small businesses?

Answer 93

+This is money raised through selling shares to individuals or businesses who specialise in giving finance to new or expanding small firms.

+Venture capitalists will usually buy shares in businesses that are risky but have the potential to grow quickly - they will take a stake in the business, and may expect returns more quickly than other shareholders would.

Question 94

How is retained profit a long term source of finance for small businesses?

Answer 94

+These are profits that the owners have decided to plough back into the business after they’ve paid themselves a dividend.

Question 95

How is crowd funding a long term source of finance for small businesses?

Answer 95

+This is when a large number of people contribute money towards starting up a business or funding a business idea.

+It’s often used for creative or innovative businesses and usually takes place online.

+Normally each person only contributes a small amount of money - sometimes the people that contribute may get a reward in return.