2.3 Managing Finance Flashcards by Isabel Thornton

What does an Income statement measure?

Measures the business income & costs over previous year.

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Profit Formula

Profit = total sales - total costs

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3 measurements of profit

-Gross profit
-Operating profit
-Net profit

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What is Gross profit formula?

revenue - cost of sales

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What is ratio analysis?

Analysing relationships between financial data to assess the performance of a business

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Gross profit margin formula

gross profit/revenue x100

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Operating profit formula

Gross profit - operating expenses

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Operating profit margin formula

Operating profit / revenues x100

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What is a balance sheet ?

Shows the financial structure of a business and identifies the assets and liabilities and the specific capital used to fund the business.

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Define Liquidity

The ability of a business to meet its short term commitments with its available assets

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Current ratio formula

Current ratio = current assets/current liabilities

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Acid ratio formula

Acid ratio = (Current assets - stock) / current liabilities

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Define working capital

Working capital is the cash needed to pay for the day to day operation of the business

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Working capital formula

working capital = current assets - current liabilities

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Main causes of cash flow problems

-low profits or losses
-Too much production capacity
-Excess inventories sold
-Over trading

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Define overtrading

Where a business expands too quickly putting pressure on short term finance

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Ways to improve liquidity

-Reduce credit period offered to customers
-Ask suppliers for extended repayment period
-Make use of overdraft facilities
-Sell excess stock

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What is debt factoring?

the selling of debtors to a third party - this generates cash but reduces income and profit

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What is trade credit?

Amounts owed to suppliers for goods supplied on credit and not yet paid

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What does a ratio of 1.5-2 suggest?

Efficient management of working capital

What does a low ratio (below 1) indicate?

Indicates cash flow problems

Drawbacks of stockholding?

Liquidity problems, to much cash ‘tied up’ in stock

What are some internal reasons for business failure?

-Poor planning
-Lack of leadership, inefficient management
-Ineffective marketing
-Cash flow problems
-Lack of funds

External causes of business failure

-Economic challenges
-Changes in consumer tastes
-Legal factors
-Market challenges (competitor actions)
-Technological change

Poor planning (internal)

-Ineffective business plan -Poor budgeting -Lack of R&D -Little innovation

Lack of leadership/Inefficient management (Internal)

-Poor decision making -Failure to delegate -Lack of skills/experience -Difficult to operate day to day

Ineffective marketing (Internal)

-Not enough market research -Poor understanding of customers

Lack of funds (Internal)

-Failure to attract investment -Difficulties borrowing -Limited capital

Net profit formula

Operating profit +/- finance costs

Net profit margin formula

Net profit / sales revenue X100

What are 3 ways to improve profitability?

1. Increase selling price 2. Reduce variable costs 3. Reduce expenses

Improving Profitability: Raising prices

-If costs remain same this will improve profitability -Raising prices impacts demand so must understand PED -Price inelastic = raising prices = increased revenue -Price Elastic = raising prices = decreased revenue

Improving Profitability: Reducing Variable costs

-Cheaper resources, buying in bulk, negotiating with suppliers -Must ensure reducing variable costs will not have an adverse effect on quality -Buying stock in bulk may require investment in more storage space = extra costs

Improving Profitability: Reduce expenses

-Reducing staff levels, relocating to cheaper premises -Reducing staff levels may affect staff morale & negatively affect productivity -Relocation costs can outweigh benefits of moving to cheaper locations

Define Cash

The money flowing in and out of a business

When is a business likely to fail?

If it doesn't have sufficient cash, struggle to pay suppliers and employees.

Improving liquidity: Reduce credit period offered to customers

-Collecting money owed quicker will increase level of current assets in the business. -However customers may move to competitors that offer better payment terms.

Improving liquidity: Ask suppliers for extended repayment terms

-Businesses cash then use cash for other purposes -Suppliers may be unwilling to extend credit.

Improving liquidity: Make use of overdraft facilities

-Current liabilities will increase -Businesses can spend more -Banks may be reluctant to lend to businesses with cash flow problems

Improving Liquidity: Sell of excess stock

-Less liquid assets will be reduced and converted into more liquid forms eg cash -Storage costs may also be reduced -Stock may need to be sold at a low price to attract sales.

How can a business have to much working capital?

-If it holding large amounts of cash it is likely to be missing out on benefits of investing in its fixed assets or investments -If a business is holding large amounts of stock it may incur extra storage costs and could use the cash 'tied up' in this stock for other purposes

Which acid test is best appropriate for businesses than hold little stock?

Current ratio

Which acid test is most appropriate for a business that holds large amounts of stock?

Acid test ratio

How is the acid test more realisitic?

As it deducts stock which is the least liquid form of current assets

Economic challenges (External business failure)

-Rising interest -Recession -Increased costs -Exchange rates

Changes in consumer tastes (External business failure)

-Need for frequent market research which increases costs

Market challenges (External business failure)

-Competitor actions -Prices

What other reasons are there for business failure beyond a businesses control?

-Changes in legislation -Economic challenges -Entry of new competition