1.3 putting your business idea into practice

Question 1

Fixed costs/indirect costs

Answer 1

Costs which do not change in relation to output
e.g. rent, Salaries & Wages not linked to Output/Sales, insurance, Utilities (gas, water, electricity), Marketing Costs, Interest on loans

Question 2

variable costs/direct costs/ cost of sales

Answer 2

Costs which change as a result of changes in output
e.g. Raw materials for manufacturing, Shipping& deliverycharges, Packaging, Marketing costs based on sales(e.g.% commission)

Question 3

revenue/turnover/sales

Answer 3

The amount ofincome received from selling goods or services

Question 4

gross profit

Answer 4

profit only taking variable costs into account

Question 5

net profit/ operating profit

Answer 5

profit taking both variable and fixed costs into account

Question 6

cash

Answer 6

money in the bank

Question 7

Price

Answer 7

what the customer pays

Question 8

Cost

Answer 8

what the business pays to make the good or serve thecustomers

Question 9

Breakeven

Answer 9

Shows how many units a firm needs to produce and sell in order to cover its costs

It is the point at which total costs equal total revenue and therefore where no profit or loss is made

Question 10

sources of finance - Short-term

Answer 10

Involves smaller sums of money. Finances running costs - repayable usually within one year. These sources are always repayable.
e.g.
-Bank overdraft
-Trade credit

Question 11

sources of finance - long-term

Answer 11

Involves larger sums of money. Finances start-up or expansion costs – repayable over many years. However, not every long-term source needs to be repaid.
e.g.
-Personal savings
-Loans – friends/family, banks
-Share capital
-Venture capital
-Crowd funding
-Retained profit

Question 12

sources of finance - Short-term - bank overdraft

Answer 12

A short-term source of finance that is available to help fund the day-to-day payments required by a business. It allows the business to withdraw funds from its account that are not there, up to an agreed maximum limit, and is only used when the business requires additional, temporary amounts of money.

Question 13

sources of finance - Short-term - bank overdraft pros

Answer 13

-Offers flexibility
-Important source of finance for a business if it has a short-term shortage of cash or unexpected cost to pay
-Interest is only paid on the amount used

Question 14

sources of finance - Short-term - bank overdraft cons

Answer 14

-Repayable to the bank at any time
-A bank may lower or even withdraw the overdraft facility at any time
-Usually has high levels of interest; using overdrafts is therefore an expensive form of finance

Question 15

sources of finance - Short-term - trade credit

Answer 15

Trade credit is provided by a firm’s suppliers, allowing the business to have the goods now and pay for them at a later date.

Question 16

sources of finance - Short-term - trade credit - pros

Answer 16

-This can allow the business to use the goods in the manufacturing process and/or sell the goods before it pays the suppliers, which will improve its cash-flow position

Question 17

sources of finance - Short-term - trade credit - cons

Answer 17

-Danger of bad reputation and losing future credit arrangements with the supplier, if bills are not paid on time
-Difficult for new start-up businesses to negotiate trade credit with suppliers, as there is a risk that the business will fail and suppliers may end up not getting paid

Question 18

sources of finance - long-term - personal savings

Answer 18

An entrepreneur will often invest personal savings, redundancy or inheritance money into a start-up. This can also be in the form of providing assets for the business, for example an entrepreneur using his/her own car.

Question 19

sources of finance - long-term - personal savings - pros

Answer 19

-Provides a strong signal to other potential investors and the bank of the entrepreneur’s commitment to the business
-It is interest free
-Readily available and maximises the control the entrepreneur keeps over the business

Question 20

sources of finance - long-term - personal savings - cons

Answer 20

-The amount that is available may be limited, resulting in the entrepreneur having to use other sources of finance to fund the business

Question 21

sources of finance - long-term - loan (friends & family)

Answer 21

Friends and family, who are supportive of the business idea, may be willing to provide money either directly to the entrepreneur or into the business.

Question 22

sources of finance - long-term - loan (friends & family) - pros

Answer 22

-This can be quick and cheap to arrange (certainly compared with a bank loan)
The interest and repayment terms may be more flexible than a bank loan

Question 23

sources of finance - long-term - loan (friends & family) - cons

Answer 23

-Increased stress for the entrepreneur, particularly if the business gets into difficulties, as it can cause family/friend disagreements
-The amount available may be limited, resulting in this source of finance having to be combined with other sources of finance

Question 24

sources of finance - long-term - loan (banks)

Answer 24

A bank loan is an amount of money borrowed for a set period with an agreed repayment schedule. The repayment amount will depend on the size and duration of the loan, as well as the rate of interest.

Question 25

sources of finance - long-term - loan (banks) - pros

Answer 25

-Guaranteed the money for a certain period - generally three to ten years
-No need to provide the bank with a share in the business, so no control is lost
Interest rates may be fixed for the term, making it easier for an entrepreneur to forecast interest payments and cash-flow
-Repayments are made in instalments meaning the business can access substantial amounts of cash that does not need to be paid in one-go

Question 26

sources of finance - long-term - loan (banks) - cons

Answer 26

-Time consuming - a new business would need to produce a detailed business plan in order to gain a bank loan
-Security - normally has to be given to the bank on some of the assets of the business/entrepreneur’s personal assets; the bank will have control over these assets if the business fails
-Lack of flexibility - a small business might take a loan out for £50,000, but finds it only needed £30,000; interest must be paid on the full loan amount, which increases the costs of the business

Question 27

sources of finance - long-term - share capital

Answer 27

Small or new businesses that are set up as private limited companies can raise finance by selling shares in the company.

Question 28

sources of finance - long-term - share capital - pros

Answer 28

-Large sums of money can be raised
-Capital does not have to be repaid
-There is no interest – dividend payments can be missed if profits are low

Question 29

sources of finance - long-term - share capital - cons

Answer 29

-Possible loss of control if the original owners sell more than 50% of the total shares
-Need to satisfy shareholders expectations of dividends and share price growth

Question 30

sources of finance - long-term - venture capital

Answer 30

Venture capital can be gained from professional investors, who typically invest between £10,000 to £750,000 into businesses that may be seen as high risk, but have the potential to be very successful. Venture capitalists tend to have made their money by setting up and selling their own business – in other words they have proven entrepreneurial expertise.

Question 31

sources of finance - long-term - venture capital - pros

Answer 31

-Venture capitalists often make their own skills, experience and contacts available to the firm
-They have access to large amounts of funds

Question 32

sources of finance - long-term - venture capital - cons

Answer 32

-The venture capital company or investor will usually want a share of the business and of the profits, which can result in some loss of control over the firm for the entrepreneur, which he/she may not want to give up
-Unless a business can offer the prospect of significant turnover growth within five years, it is unlikely to be of interest to a venture capital firm

Question 33

sources of finance - long-term - crowd funding

Answer 33

This is a way of raising money through a crowd funding platform, publicising a proposal seeking to attract a large number of worldwide small investors.

Question 34

sources of finance - long-term - crowd funding - pros

Answer 34

-Provides cheap investment, when other sources of external finance may not be available
-If the project is newsworthy, it might attract good publicity
-Social media can be easily used to keep investors informed of the progress of the business venture, which might then provide ongoing finance
-Investors may have experience or skills that they can offer the business

Question 35

sources of finance - long-term - crowd funding - cons

Answer 35

-Investors will need to be offered a return; this might be free use of the good or service produced or a share in the profits. Some schemes will also provide shares, which dilutes the control of the original owners of the business
-Risk that there will be a limit to the amount of money investors are willing to invest
-The business idea may not be of interest and attract little finance; time and money spent organising the crowdfunding campaign will be lost

Question 36

sources of finance - long-term - retained profit

Answer 36

When a business has worked out its profits, the owners or shareholders can decide whether to take the profits for themselves or reinvest the profits back into the business.

Question 37

sources of finance - long-term - retained profit - pros

Answer 37

A cheap form of finance, as no interest has to be paid
Flexible – business owners have complete control over how any profits are reinvested and the proportion that is kept in the business, rather than paid out as dividends
Retained profits do not dilute or reduce the ownership of the organisation. For companies, there is no risk of a takeover

Question 38

sources of finance - long-term - retained profit - cons

Answer 38

If a business needs some temporary finance because it is facing difficulties, then it is unlikely to have any profits that it can use
Growth may be slow if it is dependent on retained profits, as profits may not be high enough to finance the growth quickly
Using too many profits in the business, may upset shareholders who may feel that their dividend payments are too low

Question 39

breakeven point (in units)

Answer 39

= fixed costs/contribution per unit

Question 40

Contribution per unit

Answer 40

Contribution per unit =
selling price per unit – variable cost (per unit)

Question 41

margin of safety (units)

Answer 41

current output/sales (units) - break-even point (units)

Question 42

breakeven analysis - pros

Answer 42

-Illustrates the importance of keeping fixed costs down to a minimum
-Margin of safety calculation shows how much a sales forecast can prove over-optimistic before losses are incurred
-Helps entrepreneur & finance-providers better understand the viability and risk of a business idea
-Focuses on how long it will take before a start-up reaches profitability – the required output
-Calculations are quick and easy

Question 43

breakeven analysis - cons

Answer 43

-Unrealistic assumptions – products are not all sold for the same selling price at different levels of output; fixed costs do vary when output changes
-Sales are unlikely to be the same as output – there may be some build up of stocks or wasted output too
-Variable costs do not always stay the same. For example, as output rises, the business may benefit from being able to buy inputs at lower prices (buying power)
-Most businesses sell more than one product
-A planning aid rather than a decision-making tool

Question 44

Cash-flow

Answer 44

Cash-flow is the process of cash flowing in and out of a business i.e.
cash inflows and outflows

Question 45

Net cash flow

Answer 45

Net cash flow is the difference between cash inflows and cash outflows over a trading period

Question 46

importance of forecasting cash-flow?

Answer 46

Identifies potential shortfalls in cash balances in advance
Ensures the business can afford to pay suppliers and employees
Helps to spot problems with customer payments
Important part of financial planning
External stakeholders, such as banks, may require a regular forecast

Question 47

Main types of cash inflow

Answer 47

Sale of spare assets
Receipts from trade customers
Cash sales
Personal funds invested
Investment of share capital
Receipt of bank loan
Government grants

Question 48

main types of cash outflow

Answer 48

Income tax, VAT and corporation tax
Repayment of loans
Payment of dividends
Interest on bank loan/overdraft
Buying equipment
Payment of suppliers, for example raw materials, inventories
Payment of overheads, wages and salaries

Question 49

cashflow forecast

Answer 49

A cash-flow forecast is a table showing predicted opening balances, cash inflows, cash outflows, net cash flows and closing balances over a trading period.

Question 50

opening and closing balance

Answer 50

The opening balance is the value of cash at the start of a trading period.

The closing balance is the value of cash at the end of a trading period.

Question 51

cash vs profit

Answer 51

Profit is recorded when a sale is made, whereas cash is recorded when money is received. This means that a business selling on credit can be making a profit despite having no cash.