2.3 Managing finance Flashcards
types of profit
gross profit = revenue- cost of sales
direct costs of a business
operating profit= gross profit - operating expenses
net profit/ profit of the year= operating profit- interest
statement of comprehensive income
shows the income and expenses of a business during the financial year
calculates all types of profit
shows data from current and previous year for comparison
measuring profitability
gross profits margin = gross profit/ revenue x 100
(more preferable because more gross profit is being made per £1 of sales)
increased by:
- rating revenue/ turnover relative to the cost of sales by increasing price
- cutting cost of sales
(varies in industries)
operating profit margin = operating profit/ revenue x 100
(high preferred because more money os made on each £1 of sales)
net profit margin= net profit before tax/ revenue x 100
ways to improve profitability
raising prices
lowering costs:
buying cheaper resources
using existing resources more efficiently
difference between cash and profit
a business may receive cash at the beginning of the trading year from sales made in previous year. increase cash balance but not affect profit
owners might introduce more cash into th business- increase cash balance but not effect profit
purchases of fixed assets will reduce cash balances but will have no effect on the profit a company makes because purchase of assets is not treated as a business cost in the profit and loss account
statement of financial position
provides a summary of its assets liabilities and capital
value of assets will equal the vale of liabilities ad capital.
assets = capital+ liabilities
non current assets: Long term resources that will be used repeatedly by the business over a period of time
current assets: assets that can be turned into cash within 12 months. liquid assets
current liabilities: any money owed by a business that must be repaid within one year
non current liabilities: do not have to be repaid for at least one year
net assets: total assets- total liabilities and equal to shareholders equity
measuring liquidity - current ratio
current ratio = current assets/ current liabilities
sufficient liquid resources if ratio between 1.5:1 and 2:1
not enough working capital if below 1.5:1
1:1 or below because they hold fast selling stock and generate cash from sales
above 2:1 because too much money tied up unproductively
measuring liquidity- acid test ratio
stock is not treated as liquid resources as there is no guarantee that stocks can be sold
current assets- inventories/ current liabilities
less than 1:1 means that current assets minus socks do not cover its liabilities
retailers with strong cash flow may operate with ratio less than 1
what is working capital
amount of money needed to pay for the day to day trading of a business like wages, electricity
amount left over after all current debts have been paid
current assets- current liabilities
reflects how well a business is performing
managing working capital
dependent on: size of business (larger and expanding business need more cash) & levels of stock (higher = more capital needed)
not enough working capital: pay bills, creditors and buy stock
too much: stocks are costly to keep, cash= not earning interest
ways to improve liquidity
prevented by a tight control of finance resources , using budgets and cashflow forecasts
(problems= must raise current assets or reduce current liabilities)
- use overdrafts BUT no guarantee a bank will increase limit if already reached
- negotiate additional short or long term loans BUT may be reluctant to provide due to collapse
- encourage cash sales and sell off stock by offering large discounts (stock costs money to hold)
- sale and leaseback BUT may take a while to set up agreements
- only make essential purchases
- extend credit with suppliers
internal causes of business failure
lack of planning
lack of funds
narrow customer base
marketing problems
failure to innovate
changes to legislation
cash flow problems:
- over trading (fund large production with inadequate cash)
- investing too much in fixed assets
-allowing too much credit (customers can wait to pay = business force to borrow)
- over borrowing (interest rates rise)
- seasonal factors
- external factors
external causes of business failure
conception
changes in legislation
change in consumer wants
economic conditions
