2.3 Managing Finance Flashcards
Types of Profit
Gross Profit ( GP ) :
- The difference between revenue and the costs directly related to production
- GP = Revenue - Cost Of Sales
Operating Profit ( OP ) :
- The difference between the gross profit and the indirect expenses involved in operating the business
- OP = Gross Profit - Operating Expenses
Net Profit ( NP )
- The difference between the operating profit and any Interest paid and received, as well as any one off costs
- NP = Operating Profit - ( Net Interest + Exceptional Costs )
Statement of Comprehensive Income
The Statement of Comprehensive Income is an end of year financial statement that shows all of a businesses income and expenses over the previous twelve months
Analysis:
- Cost of sales increasing isn’t always bad … ↑ Sales Revenue
- Reducing cost of sales by finding cheaper suppliers… worsen quality ∴ ↓ Sales Revenue
- Increasing marketing = ↑ Operating expenses ∴ ↑ Sales Revenue
- Statement of Comprehensive Income 🠮 Ratio Analysis
Gross Profit Margin ( GPM )
Operating Profit Margin ( OPM )
Net Profit Margin ( NPM )
( Ratio Analysis ) Equations:
This shows the proportion of revenue that is turned into gross profit and is expressed as a percentage
Equation:
Gross Profit / Revenue × 100
The Operating Prot Margin shows the proportion of revenue that is turned into operating profit and is expressed as a percentage
Equation:
Operating Profit / Revenue × 100
The net profit margin (also know as the profit for the year margin) shows the proportion of revenue that is turned into net profit before tax and is expressed as a percentage
Equation:
Profit For The Year / Revenue × 100
How To Improve Profitability
Raising Prices:
- If costs remain the same this will improve profitability as the difference between the selling price and
costs is now greater
- Where demand for products is price inelastic, increasing prices will increase revenue
Reducing Variable Costs:
- Buy Cheaper Stock
- Purchase in bulk
- Change Packaging
- Seek New Suppliers
Reducing Other Expenses:
- Seek new suppliers
- Reducing staffing levels
- Relocate business
- Replace inefficient fixed assets
Reducing One Off Costs And Interest Charges:
- Implement zero budgeting
- Delay capital spending
- Lease Fixed Assets
- Restructure Borrowing
Statement of Financial Position
A snapshot of a company’s equity, assets and liabilities at a single point in time
- What you Own
- What you Owed
- What you Owe
- Known as the Balance Sheet
Total Net Assets = Total Equity
Cashflow & Profit
PROS / CONS
Profit is simply the difference between revenue generated and business costs ( Revenue - Costs )
Cash is measured by taking into account the full range of money flowing in and out of a business ( Inflows - Outflows )
PROS of Positive Cash Flow:
- Able to play suppliers / employees on time
- Able to handle unforeseen events
- Able to take advantage of opportunities
- Provides to expand the business
Gross, Operating, Net & Retained Profit
Equations
Gross Profit = Revenue - Direct Costs
- Pricing Decisions
- Production Efficiency
- Control excess Production Costs
Operating Profit = Gross Profit - Indirect Costs
- Operating Expenses
- Operating Performance
- Control excess Operating Cost
Net Profit = Operating Profit - Intrest & Taxes
- Overall Profitability
- Conversion of sales 🠮 Profit
Retained Profit 🠮 found on Balance sheet
- Retained profit is the money a business keeps from its earnings after paying dividends and taxes. It’s used to reinvest in the business or save for the future.
Current Ratio - ( Liquidity Ratio )
Equation:
Current Ratio = Current Assets / Current Liabilities
This measures a business’s ability to pay its short-term debts using its short term assets.
Current Assets 🠮 Cash, Stock, Debtors
Current Liabilities 🠮 Creditors, Overdraft,
EVALUATION:
High Number ( 10 )
What’s the reason?
🠮 Debtors - Too slow chasing up debts
🠮 Cash - Could you be doing something better with your cash?
🠮 Stock - Why so much?
- Good Liquidity
- Poor working capital management
Low Number ( 0.5 ) = Unable to cover short-term liabilities
- Poor Liquidity
- Poor working capital management
The Acid Test Ratio
Equation:
This measures a business’s ability to pay its short-term debts without relying on selling inventory.
AcidTestRatio = Current Assets − Inventory / Current Liabilities
High Ratio ( above 1:1 )
- The business has strong liquidity and can comfortably pay its short-term debts without selling inventory.
- Indicates good financial health but could also mean the business isn’t efficiently using its resources.
Low Ratio ( below 1:1 )
- The business might struggle to pay its short-term debts without selling inventory, which can be risky.
- Indicates weaker liquidity and potential cash flow issues.
Methods to Improve Liquidity
- Reduce the credit period offered to customers
- Ask suppliers for an extended repayment period
- Make use of overdraft facilities or short term loans
- Sell off excess stock
- Sell assets and lease fixed assets instead
- Introduce new capital and reduce drawings from the business
Operational Objectives
- Reduce Unit Costs
- Higher profit margins / Lower prices
- Fixed Costs 🠮 Variable Cost
- Increase Scale : Economies Of Scale - Increase Quantity
- ↑ Quality ∴↑ Customer Satisfaction = ↑ Reputation = ↓ PED = ↑ P & ↑ R
- Recalls, Complaints etc - Respond Speed + Flexibility
- Response to Customers orders and questions
- Meeting delivery agreements
- Levels of output, Range, New Product - Dependability
- Customers get what they want? - Environmental
- Carbon Footprint / Consideration of Communities - Create Added Value
- Increase distance between price and unit costs
Managing Working Capital
WorkingCapital = CurrentAssets − CurrentLiabilities
Why is it important?
- Ensures the business can meet short-term obligations.
- Helps maintain smooth operations ( e.g. paying suppliers and employees )
- Avoids liquidity issues or cash shortages.
Key Tips for Managing Working Capital:
- Monitor Cash Flow = Ensure there’s enough cash for day-to-day expenses.
- Manage Inventory = Avoid overstocking or understocking.
- Control Receivables and Payables = Speed up customer payments and negotiate better terms with suppliers.
- Plan for Seasonal Demand = Adjust resources to meet high or low demand periods.
Internal Causes of Business Failure
Poor Planning:
- Poor Budgeting
- Lack of research, development, innovation
- Ineffective Business Plan
Lack Of Leadership:
- Poor Decision Making
- Failure To Delegate
- Lack Of Skills
Ineffective Marketing:
- Not Enough Market Research
- Promotional Mistakes
- Poor Understanding Of Customer Needs
Cash Flow Problems:
- Flawed Products & Pricing Decisions
- Not Enough Market Research
- Poor Understanding Of Customer Needs
Lack Of Funds:
- Failure To Attract Investment
- Limited Owner Capital
- Difficulties In Borrowing
External Causes of Business Failure
Economic Challenges:
- Recession Due To Reduced Demand
- Rising Interest Rates Increase Business Costs
Changes In Consumer Taste:
- Frequent Market Research Which Increases Cost
Legal Factors:
- Legal Rulings Can Affect Business Operations
- Legislation Can Increase Staffing & Travel Costs
- Products Or Assets May Need To Be Registered Or Replaced To Meet Changed Legal Standards
Market Challenges:
- Competitors Undercut Prices To Gain Market Share
- Market Selling Prices May Be Too Low To Achieve Break Even
Technological Change:
- Product Innovation Leads To Disappearance Of A Business Market
