1.3 putting your business idea into practice Flashcards
Fixed costs/indirect costs
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
variable costs/direct costs/ cost of sales
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)
revenue/turnover/sales
The amount ofincome received from selling goods or services
gross profit
profit only taking variable costs into account
net profit/ operating profit
profit taking both variable and fixed costs into account
cash
money in the bank
Price
what the customer pays
Cost
what the business pays to make the good or serve thecustomers
Breakeven
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
sources of finance - Short-term
Involves smaller sums of money. Finances running costs - repayable usually within one year. These sources are always repayable.
e.g.
-Bank overdraft
-Trade credit
sources of finance - long-term
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
sources of finance - Short-term - bank overdraft
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.
sources of finance - Short-term - bank overdraft pros
-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
sources of finance - Short-term - bank overdraft cons
-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
sources of finance - Short-term - trade credit
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.
sources of finance - Short-term - trade credit - pros
-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
sources of finance - Short-term - trade credit - cons
-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
sources of finance - long-term - personal savings
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.
sources of finance - long-term - personal savings - pros
-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
sources of finance - long-term - personal savings - cons
-The amount that is available may be limited, resulting in the entrepreneur having to use other sources of finance to fund the business
sources of finance - long-term - loan (friends & family)
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.
sources of finance - long-term - loan (friends & family) - pros
-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
sources of finance - long-term - loan (friends & family) - cons
-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
sources of finance - long-term - loan (banks)
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.
sources of finance - long-term - loan (banks) - pros
-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
sources of finance - long-term - loan (banks) - cons
-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
sources of finance - long-term - share capital
Small or new businesses that are set up as private limited companies can raise finance by selling shares in the company.
sources of finance - long-term - share capital - pros
-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
sources of finance - long-term - share capital - cons
-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
sources of finance - long-term - venture capital
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.
sources of finance - long-term - venture capital - pros
-Venture capitalists often make their own skills, experience and contacts available to the firm
-They have access to large amounts of funds
sources of finance - long-term - venture capital - cons
-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
sources of finance - long-term - crowd funding
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.
sources of finance - long-term - crowd funding - pros
-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
sources of finance - long-term - crowd funding - cons
-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
sources of finance - long-term - retained profit
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.
sources of finance - long-term - retained profit - pros
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
sources of finance - long-term - retained profit - cons
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
breakeven point (in units)
= fixed costs/contribution per unit
Contribution per unit
Contribution per unit =
selling price per unit – variable cost (per unit)
margin of safety (units)
current output/sales (units) - break-even point (units)
breakeven analysis - pros
-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
breakeven analysis - cons
-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
Cash-flow
Cash-flow is the process of cash flowing in and out of a business i.e.
cash inflows and outflows
Net cash flow
Net cash flow is the difference between cash inflows and cash outflows over a trading period
importance of forecasting cash-flow?
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
Main types of cash inflow
Sale of spare assets
Receipts from trade customers
Cash sales
Personal funds invested
Investment of share capital
Receipt of bank loan
Government grants
main types of cash outflow
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
cashflow forecast
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.
opening and closing balance
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.
cash vs profit
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.
