2.3 - Managing Finance Flashcards
Gross profit
Difference between a business’ sales revenue and cost of sales (variable costs)
Operating profit
Difference between a business’ sales revenue and total costs
Net profit
Difference between a business’ sales revenue and total costs plus interest and taxes
Formula for Gross Profit Margin
(Gross profit / Sales revenue) * 100
Formula for Operating Profit Margin
(Operating profit / Sales revenue) * 100
Formula for Net Profit Margin
(Net profit / Sales revenue) * 100
Ways to increase profitability
- Increase price
- Increase quantity sold
- Decrease costs
Liquidity
How easily a business can convert its assets into cash to meet short-term obligations or expenses
Balance sheet
Snapshot of the business’ assets and liabilities on a particular day
Formula for current ratio
Current assets / Current liabilities
Formula for acid test ratio
Current assets - Stocks / Current liabilities
Evaluating current ratio values
A ratio of 1.5 to 2 would suggest efficient management of working capital, but a low ratio of below 1 indicates cash problems
Evaluating acid test ratio values
Significantly less than 1 is often bad news
Main causes of cash flow problems
- Low profits or losses
- Excess inventories
- Allowing too much credit
- Overtrading
- Seasonal demand
Overtrading
When a business expands too quickly putting pressure on short term finance
Methods to improve liquidity
- Reduce amount of stock held
- Reduce credit period offered
- Pay suppliers later on agreed terms
Debt factoring
Financial transaction where a business sells its accounts receivable (outstanding invoices) to a third party, called a factor, at a discount in exchange for immediate cash. This allows the business to receive funds quickly instead of waiting for customers to pay their invoices
Financial reasons for business failure
- Poor cash flow management
- Lack of profitability
- High debt levels
- Inadequate financing
Non-financial reasons for business failure
- Lack of management control
- Significant external shocks
- Poor marketing
- Intense competition
External shocks
Unforeseen events or changes in the external environment that can disrupt the normal functioning of an economy or business operations. These shocks are typically beyond a business’s control and can have significant and sudden effects on performance, profitability and even survival
