2.3 - Managing Finance Flashcards
Formula for gross profit
Gross profit = total revenue - cost of sales
Formula for operating profit
Operating profit = gross profit - fixed overheads
Formula for the profit for the year (net profit)
Profit for the year (net profit) = operating profit - (net financing cost and corporation tax)
Define ‘statement of comprehensive income’ or ‘profit and loss account’
Is a document produced by public limited companies that shows revenue, a break-down of different types of costs and different types of profit for a year
Formula for gross profit margin
Gross profit margin = (gross profit / sales revenue) x 100
Formula for operating profit margin
Operating profit margin = (operating profit / sales revenue) x 100
Formula for profit for the year margin or net profit margin
Profit for the year (net profit) margin = (profit for the year (net profit) / sales revenue) x 100
2 ways a firm can improve profitability
• Increase selling price • Cut costs
Ways of improving profitability - increase selling price
• Will increase profit margin but may decrease overall profit - as an increase in price may lead to drastic decrease in sales volume if the product is price elastic • This will be effective for price inelastic products/services as an increase in price will have little impact on sales volume
Ways of improving profitability - cut costs (2)
• This can simply be through using cheaper materials or employing fewer staff however this can damage a firm’s reputation thus revenue • Only where genuine waste can be identified and painlessly removes from the business is cost reduction likely to lead to a straight forwards increase in profitability
Differences between net cash flow and profit (2)
• Sales revenue does not equal cash inflows • Costs do not equal cash outflows
What is a statement of financial position (balance sheet)
Is a document which shows what business owns as well as what it owes and where it got its money from
Formula for current ratio
Current ratio = current assets / current liabilities
Formula for acid test ratio
Acid test ratio = (total current assets - inventories) / current liabilities
Ways to improve liquidity (4)
• Selling under-used fixed assets such as equipment or machinery • Raising more share capital • Increasing long-term borrowing through loans • Postponing planned investments
Importance of cash (3)
• Control cash used • Minimise spending on fixed assets • Plan ahead
Importance of cash - control cash used
Involves keeping the amount of cash used as low as possible by reducing stock levels, controlling credit periods offered to customers and gaining as much credit as possible from suppliers, and getting products on sale as quickly as possible
Importance of cash - minimise spending on fixed assets
This can be helped by leasing rather than buying new assets - this prevents large outflows of cash draining working capital from the system
Importance of cash - plan ahead
This is to estimate carefully the amount of cash that will be needed in the next few months - this ensures that adjustments to the cycle can be made in good time
Internal causes of business failure (3)
• Marketing failure • Financial failure • Systems or operations failure
Internal causes of business failure - marketing failure
Problems understanding changes in the marketplace or what consumers are really looking for - leads to a decrease in revenue
Internal causes of business failure - financial failure (2)
• Managers need to manage finances actively, planning ahead and make adjustments when necessary • Failing companies sometimes stumble into cash flow crises without seeing them coming
Internal causes of business failure - systems or operations failure (2)
• If IT systems don’t provide the right people within the business with the information needed things can start to go wrong • If physical systems breakdown e,g manufacturing or ordering stock the business will find itself unable to satisfy demand for its product and will rapidly lose customers
External causes of business failure (4)
• Changes in technology • New competitor • Economic change • Behaviour of banks
External causes of business failure - change in technology (2)
• A major technological advancement can destroy a company’s sales rapidly • As a product struggles to compete against a better product, price cutting is almost assured and ultimately the company may fail to operate at a break even point
External causes of business failure - new competitor
New competitors that are able to operate far more efficiently may cause such a large effect as to drive existing businesses out of the market and out of business
External causes of business failure - economic change (2)
•In times of economic downturn firms that sell luxury goods may encounter a decrease in sales • if economic growth does not recover quickly, some business will find it hard to continue operating above their break-even point potentially leading to business failure
External causes of business failure - behaviour of banks
A failure to supply credit to businesses or forcing businesses to accept unreasonably high interest rates can lead to business failure
Financial cause of business failure (2)
• Operating below break-even for a sustained period of time • Having insufficient cash flow - meaning the business cannot cover its current liabilities
Non financial causes of business failures (4)
• lack of management control - as in not developing a credible business plan • Failure to understand markets and key customers - e.g underestimating competitors’ levels of customer loyalty • Failure to administer the business properly - e.g poor methods of motivation and leadership of staff • Significant illegality or unethical behaviour leading to substantial business cost
