2.3 - Managing Finance Flashcards
Define profit
The amount of money left over when a business subtracts its costs from its revenue
Define profitability
Refers to how much profit is made in relative terms ( eg compared to the level of sales made )
Gross profit
Shows how much profit a business makes before it’s fixed costs are taken into account
= revenue - cost of sales
What is cost of sales
The direct costs of producing the product being sold. Variable costs used to produce the products e.g. Raw materials , stock used
Operating profit
The profit that’s been made in total from the trading activities of the business.
= gross profit - other operating costs
Other operating costs are the fixed costs that are not related to producing the products sold e.g. Wages, distribution costs
Net profit
Is the true profit ta business has made in a trading period
= sales revenue - total costs
Net profit after tax = net profit - taxation
What are profitability ratios ?
They allow us to compare:
- profit made relative to level of sales
- profitability vs previous years
- profit relative to the amount of money invested in the business
Gross profit margin
Tells us how much gross profit a business generates for every £1 of its sales.
= gross profit ➗ revenue X 100%
Operating profit margin
Tells us how much operating profit is made from every £1 of sales.
= operating profit ➗ revenue X 100%
Net profit margin
The higher the percentage figure, the better the firm has performed in terms of profit.
= net profit ➗ revenue X 100%
What is the difference between profit and cash flow
Cash flow is the difference between total cash inflows and total cash outflows over a period of time. Profit is the difference between sales revenue and total costs. Some cash flows are generated from the way the business is financed, not from sales.
How do you increase net profit
- increase sales volume
- lower fixed/variable costs
What is working capital
The finance a business has available to fund its day to day activities.
= current assets - currents liabilities
Currents assets are..
Items that a business owns that it expects to turn into cash within the next 12 months e.g. Cash in the bank, debtors, raw materials, stocks of finished goods
Currents liabilities are..
A firms short term debts that it will have to pay inside the next 12 months. E.g. Money owed to creditors, tax due to be paid, overdraft, dividends not yet paid to shareholders.
What is the working capital cycle?
The money that is used day to day going around the business in and out. E.g. A firms say to day expenditure ( wages, stock) is financed using the income that is generated from sales.
What does measuring liquidity involve?
Comparing the size of a firms currents assets to the size of its current liabilities in order to asses whether it has sufficient short term assets to cover its short term debts.
How do we measure a firms liquidity ?
Ratios -
- current ratio
- acid test ratio
Current ratio
This tells us how many £s of currents assets a business has available for every £1 of its current liabilities.
= current assets ➗ currents liabilities (>1.5 is stable )
Acid test
Tells us whether a firm will still be able to pay its debts even if it’s not able to sell any of the stock that is recorded.
= (current assets - stock) ➗ currents liabilities (>1 is stable )
Why do businesses experience cash flow problems ?(7)
- lack of sales
- costs too high
- length of credit period too long
- poor credit control
- bad debts
- holding too much stock
- unexpected events
How do businesses deal with cash flow problems? (3)
- speed up or increase the amount of cash coming into the business
- delay or decrease the amount of cash leaving the business
- arrange finance to cover the problem.
Why do new businesses fail? (3)
- no demand for the idea
- good idea but poorly executed
- external shocks
Why do established businesses fail? (4)
- Poor management of cash flow
- inappropriate financing
- lack of management cement control
- significant external shocks
