2.3 managing finance Flashcards
What is the equation for gross profit?
Revenue - cost of sales
What is the equation for operating profit?
Gross profit - fixed overheads
What is the equation for net profit (profit for the year)?
Operating profit - financing and tax
What are the three types of profit?
- Gross profit
- Operating profit
- Net profit
What is revenue?
Value of all the sales to customers
What is cost of sales?
The cost of all raw materials needed
What are the fixed overheads?
The cost of rent, salaries and bills (electricity and advertising)
What are public limited companies (plc) required to do?
They have to state their annual profits in a document called ‘statement of comprehensive income’. The document sets out the revenues generated in the year with all the costs included. From this the three different types of profit can be measured. The after- tax net profit shows how much the directors can pay out in shareholder dividends
What is the gross profit margin calculation?
Gross profit margin = gross profit/ sales revenue x 100
What is the operating profit margin calculation?
Opm = operating profit/ sales revenue x 100
what is the calculation for the net profit margin?
npm = profit for the year/ sales revenue x100
what are 3 ways of improving profits?
- increase revenue
- decrease costs
- do a combination of both 1 and 2
what are two ways to improve profitability?
- Increase the price
2. cut costs
what does a business need to be careful of when cutting costs?
not cutting quality
how do you distinguish revenue from cash inflow?
revenue is the value of sales made over a specified period, which could be by cash, credit card or a store card, but the cash in is just the money made from the cash.
what is the definition of corporation tax?
a levy on the incomes of companies (i.e. you pay a percentage of your pre tax profit)
what is the definition for dividends?
annual payments made to shareholders
what is the definition of fixed overheads?
the indirect costs that have to be paid however the business is performing (rent)
what is the difference between gross profit and operating profit?
fixed overheads
how to measure liquidity
identify the current liabilities (bills) and the current assets, and as long as the current assets is higher than the liabilities then the company has sound liquidity
what is the calculation for current ratio?
current ratio = current assets/ current liabilities
what is the ideal current ratio?
1.5:1. so this is £1.50 of assets for every £1 of debt. any higher than this and the business could be criticised for having too many resources tied up in unproductive assets and a low current ratio means the business may not be able to pay back its debts.
what is the acid test ratio?
it examines the businesses liquidity position by comparing current assets and liabilities but it omits stock from the total currents assets
what is the formula for acid test ratio?
(current assets - inventories)/ current liabilities
what is the ideal acid test ratio?
1:1. this shows the organisation has £1 of highly liquid assets to every £1 short term debt
what are 4 ways to improve liquidity?
- selling under fixed assets
- raising more share capital
- increasing long term borrowings
- postponing planned investments
what is the working capital cycle?
(capital is injected into the business) > sell to customers on credit > customers (debtors) pay up > buy materials > produce goods (back to selling to customers)
what two things is managing capital about?
- ensuring the business has enough finance to meet its needs
- keeping cash moving rapidly through the cycle, so there is enough to meet all future orders
why is useful to have a generous overdraft limit?
in case of an unexpected events. for example - a major customer gets into financial difficulties and is unable to pay the bills on time or the cost of materials rises quickly
What 4 ways can businesses control the amount of cash?
- minimising stock levels
- keeping customer credit as low as possible
- trying to get as much credit from suppliers as you can
- getting goods to the armlet in the shortest possible time, the sooner the goods reach the customer the sooner the payment is received
what three aspects is the working capital management centred on?
- control cash used
- minimise spending on fixed assets
- plan ahead by estimating cash needed
Definition of contingency finance:
planning for the unexpected by either keeping a cash cushion in the firms current account or keeping an overdraft facility little-used
definition of credit period?
the length of time a supplier allows a buyer to wait before paying
Definition of liquidation:
closing the business down by selling off all the assets, paying debts and returning what is left to shareholders
Definition of liquidity?
the ability of a business to pay its bills on time, which all depends on having enough cash in the bank
Definition of working capital cycle?
how long it takes for a complete cycle from cash out (buying stock) to cash back in from a customer payment. it could vary from one day to one year
3 internal reasons for business failure:
- a marketing failure
- a financial failure
- a systems failure
4 external reasons for business failure:
- a fundamental change in technology which gives a rival/ new entrant a competitive advantage that is too great to be matched.
- the arrival of a competitor who is so effective at acquiring and keeping customers that others fall by the wayside
- economic change
- the behaviour of banks
3 reasons of financial business failure:
- the business may have been running below breakeven for some period of time. the lossmaking drains the business of its cash, as cash outflows regularly exceeds cash inflows
- a cash flow crisis
- overtrading
definition of administration:
when the directors of a business feel forced by the threat of insolvency to hand over management control to an administrator, who may try to sell the business or close it down and sell off the assets
Definition of business model:
an underlying plan of how the business is going to make a profit in the long term
give 4 examples as to why a business cannot pay back debt:
- employees on strike
- business has gone bust
- increased costs (from suppliers)
- a breakeven issue
- customer sales have gone down
- delayed payment from debtors
how can a business increase profit, by increasing the revenue? (5)
- advertising
- put the price up (sppu)
- specialise the product - unique selling point
- innovate/ rebrand
- expand product range
how can a business increase profit, by decreasing costs? (6)
- lower material costs
- change supplier
- change location
- change organisational structure
- change organisational structure (make it flatter - delayer)
- economies of scale (bulk buy)
