2.3 Managing Finance Flashcards
what is amortisation?
the writing off of an intangible asset
what is cost of sales?
the direct costs of a business
what is meant by exceptional costs?
a-one-off costs such as a large bad debt
what the definition of by gross profit?
the difference between revenue/turnover and cost of sales
what is the definition of by gross profit margin?
gross profit expressed as a percentage of revenue/turnover
what is the definition of meant by operating profit?
the difference between gross profit and business overheads, such as selling and administrative expenses
what is the definition of by operating profit margins?
operating profit expressed as a percentage of revenue/turnover
what is the definition of profit for the year or net profit?
the difference between operating profit and interest and exceptional item
what is the definition of profit for the year margin or net profit margin?
net profit before tax, expressed as a percentage of revenue/turnover
What is meant by statement of comprehensive income/
a financial document showing or company’s income and expenditure over a particular time period, usually one year
What is meant by revenue or turnover?
the total income of a business resulting from sales of goods or services
What is gross profit?
- gross profit is the measure of how efficiently the business sells it goods and service
- you want this to be as high as possible
How do you calculate gross profit?
gross profit = revenue (turnover) - lost of sales
What are some examples of cost of sales?
costs of sales is the direct costs associated with the production of the product or service. that would be raw materials, wages and other costs what you may refer to as variable costs
What is operating profit?
-operating profit measures how much profit a business makes after all the business’s costs have been deducted
How do you calculate Operating Profit?
Operating profit = Gross Profit - Operating Expenses
what are operating expenses?
- operating expenses are the indirect costs of the business
- indirect costs are the equivalent of the businesses fixed costs and include expenses such as rent, office, heating and salaries of directors
What is meant by net profit?
bet profit measures the businesses final profit, before any taxes is calculated or dividend paid to shareholders
How do you calculate net profit?
Net Profit = Operating profit - interest and exceptional costs
- interest will be the difference between and interest paid by the business (on loans and overdrafts) and interest received (from savings for example)
- Exceptional items are large one off items, such as a bad debt
what is Statement of comprehensive income (profit and loss account)?
a financial document showing a company’s expenditure over a particular time frame, usually a year
How do you calculate Gross profit margin?
gross profit margin = gross profit / revenue x 100
in this case the higher the ratio the better, it shows how much gross profit is made for each £1 of sales
how can you improve gross profit margin?
to improve the gross profit margin a business would look to:
- increase revenue by increasing the price. if costs stay the same GPM will increase
- Reduce costs, Reducing the costs of sales by reducing raw material or utility cost for example would mean an increase in GPM
why will Gross Profit Margin be different in different industries?
as a rule, product with shorter lifespans have a lower GPM, a supermarket for example would make small GPM per item than a car sales dealership however the super market will generate its large profits through sales volume
how do you calculate operating profit margin?
operating profit margin = operating profit/ revenue x 100
the higher the ratio the better. its shoes how much operating profit is mad for each £1 of sales. It shows a good measure of the business’ true trading profitability, before exceptional item are taken off
why might Operating Profit be different in different industries?
- differences here are linked to the business’ overheads or fixed costs
- manufacturing industries will more likely have high overhead costs than office business due to large machinery costs compared to renting a office and buying a new computer every few years
How do you calculate net profit margin?
net profit margin = net profit/ revenue x 100
-this calculation shows the business’ profitability having taken account of ALL the costs over a course of the year
What is the most basic way of improving profitability?
profit = total revenue - Total Costs
- increase revenue
- lower costs
How can you increase revenue?
- increase price –> PED
- Increase value e.g. packaging, customer service –> increases costs?
- increase sales –> increase costs?
- improving Brand image –> increase costs? not necessarily going to increase sales
- Increasing productivity –> reduce staffing, not necessarily increase sales, staffing may want a raise –>increases costs –> staffing, training, machinery
How to reduce costs?
- Cheaper costs –> reduce quality, negotiate better pricing with original supplier
- Less waste suppliers –> efficiency, buying in bulk may still have extra waste
- Reducing packaging –> better for environment, PR, R+D–> new design increases cost
- Reduce Storage –> JIT –> not have enough, cant impulse buy, cant handle demand spikes
- reduce labour –> reduce morale
- reduce wages –> reduces morale
What is the distinction between cash and profit?
- its important that you understand the difference between cash and profit .
- Profit figures and bank balances are rarely the same
Why are profit figures and bank balances rarely the same?
this is because:
- credit sales
- timing differences
- purchasing of assets
- Owner cash injections
- Selling assets
- Opening balances
What is a statement of financial position?
a balance sheet
What is liquidity?
-liquidity is the ease with which a business’ assets can be converted into cash
it is vital that the business is able to meet its short-term debts
-this means they must have enough liquid resources (cash) to pay these debts as required
What is current ratio?
the measures the ratio of the business current assets to its current liabilities
How do you calculate current ratio?
current ratio = current assets/ current liabilities
What would a business like its current ratio to be?
- Generally a business would like its current ratio to be somewhere between 1.5:1 and 2:1
- Less than 1.5:1 and the business may struggle to meet its requirements to make payments as they fall due
- More than 2:1 and the business may be accused of not using its assets effectively
What is acid test ratio?
- similar to the current ratio, the acid test measures the business’ ability to meet its liabilities but uses a more severe
- it assumes that the business’ stock is worth less and so discounts it from the calculation
How do you calculate acid test ratio?
acid test ratio = current assets - inventories/current liabilities
What does a business want its asset test ratio value at?
- generally, a business would like its current ratio to be somewhere between 0.75:1 and 1:1
- Less than 0.75:1 and the business would struggle to meet its requirement to make payments as the fall due
- more than 1:1 and the business may be accused of not using its assets effectively
What is meant by the term assets?
resources that belong to a business
what is meant by the term capital?
money put into the business by the owners
What is meant by the term Current assets?
liquid assets i.e. those assets that will be converted into cash within one year
What is meant by Current liabilities?
money owed by the business that must be repaid within one year
What is meant by Current Ratio?
assesses whether or not a business has enough resources to meet any debts that arise in the next 12 months, it is found by dividing current liabilities into current asset
What is meant by intangible assets?
non-physical assets, such as brand names, patents, and customer lists
What is meant by inventories?
stocks, such as raw materials and finished goods held by a business
What is meant by liabilities?
money owed by the business to banks and suppliers for example
What is meant by liquidity?
the ease with which assets can be converted into cash
What is meant by net assets?
total assets - total liabilities
what is meant non-current liabilities?
money owed by the business for more than one year, sometimes called long-term liabilities
what is meant by shareholders’ equity?
the amount of money owed b the business to the shareholders
what is the definition an statement of financial position (balance sheet)?
a summary at a particular point in time of the value of a firms assets, liabilities and capital
What is meant by trade and other payable?
money owed by the business to suppliers and utilities, for example sometimes called trade creditors
what is meant by trade and other receivables?
money owed to the business by customers and any prepayments made by the business
what is working capital?
the funds left over to day-to-day expenses after current debts have been paid. it is calculated by subtracting current liabilities form current assets
- a business needs working capital to pay expenses such as wages, electricity, and gas and raw material
- working capital is the amount left over after a business has paid all its debt
how do you calculate working capital?
working capital = current assets -current laibilities
How do you interpreting working capital?
- The amount of working capital a business has can reflect o the performance of a business
- businesses with low levels of working capital could struggle to meet debt payments, so investors may see low levels of capital as a reason not to invest
how do you manage working capital?
- size of the business
- stock levels
- managing debtors and creditors
when managing working capital how is the size of the business considered?
as sales typically generate the need to purchase stock, the larger the business’ sales the more working capital will be required to replenish those stocks
when managing working capital how is stocks levels considered?
Office based businesses are likely to need lower mount of stock whereas a large retail business will need considerable volume
When managing working capital how is managing debtors and creditors considered?
- this time between buying stocks and receiving payments can have an impact on a business’ need for working capital
- sandwich making would purchase materials and sell the product the same day
- whereas a building would purchase the material and have to wait several months before receiving payment
problems of not managing working capital?
- limited stock levels
- unable to produce/ sell products
- nothing to sell equal no sales
- lower revenue reduces working capital
- business unable to pay debts
-lead to the failure of your business
what is the importance of cash?
- cash is the most liquid asset a business has. it can be spent at any time and is worth its face value
- other assets such as stocks or debtors are not as easy to convert into cash.
- stocks may be needed to be reduced to be sold quickly but reducing its value to the business
- debtors may not pay immediately particularly if trade credit has been given
- the CBI estimate that 21% of business failures is due to poor cash flow and working capital.
What are some ways to improve liquidity?
- use overdraft facilities –> easily arranged and dealt with
- negotiate short/long term loans –> depends on the nature of the issue –> high interest
- encourage cash sales –> instant cash into the business, reduces transaction free on cards
- sell of stock –> at reduce prices, bulk sales, sell all stock held
- Sales and leaseback of assets –> can increase costs in the future
- only make essential purchases –> not wasting any capital
- obtain credit from suppliers –> trade credit – gives time to sell it before hand
- reducing drawing s from the business –> do not take a lot of money out for personal use
- introduce fresh capital –> corporate routes –> issues more shares long and complicated process
- incorporate roots –> put your own money in
How do you calculate net assets employed?
net assets employed = fixed assets + net working capital - long term labilities
What is net working capital equal to?
capital employed
What is meant by the term administration?
a failing business appoints a specialist to rescue the business or wind it up
what is meant by the term external factors?
factors beyond the control of the businesses cause it to collapse
what is meant by the term internal factors?
factors that business are able to control cause it to collapse
what is meant by the tern over trading?
the situation where a business does not have enough cash to support its production and sales, usually because its growing to fast
what are internal reasons for business failure?
- lack of planning
- Cash flow problems
- lack of funds
- relying on a narrow customer base
- marketing problems
- failure to innovate
- lack of business skill
- poor leadership
how can lack of planning lead to business failure?
- a thorough business plan will allow the owners to make an objective and critical look at the business ideas
- it could provide a road map for development or identify that the business will not be successful and allow for either attractions or stopping before you start
- of particular importance is financial planning, careful budgeting and cash flow analysis is required to ensure the business doesn’t run out of cash
- seek advice from professionals
how can a lack of funding lead to business failure?
- some businesses fail because the cannot attract funding, this issue can affect both established and new businesses
- established businesses may fail to attract funding due to previous record of poor decisions making and financial track record . this could present too much risk for investors
- new businesses may struggle to attract funding due to not having past records
what are the different factors that lead to cash flow problems?
- overtrading
- investing too much fixed assets
- allowing too much credit
- over borrowing
- seasonal factors
- unforeseen expenditure
- external factors
- poor financial management
how can over trading lead to cash flow problems?
- take on too many sales
- purchasing too much and running our cash reserves too low
how can investing too much in fixed assets lead to cash flow problems?
- could have leased
- take capital from the business
how can allowing too much credit lead to cash flow problems?
- need the loyalty from the customers
- you may have sales but they may not pay you back
how can over borrowing lead to cash flow problems?
- borrowing more than you can afford
- capital and interest requirements
how can seasonal factors lead to cash flow problems ?
- people forget their products seasonality
- ice cream sales –> buy assets in winter not summer
- will have a ‘cold’ period with low sales but still many outflows
how can unforeseen expenditure lead to cash flow problems?
- may have not consider extra checks e.g. electrical wiring due to lack of planning
- break-down of a major machine
how can external factors lead to cash flow problems?
- changes in consumer taste
- change in interest/exchange rates
how can poor financial management to cash flow problems?
-lack of experience may lead to poor cash flow management as they just dont know how to
how can lack funding lead to business failure?
- Some businesses fail because they cannot attract funding. This issue can affect both established and new businesses.
- Established businesses may fail to attract funding due to previous record of poor decision making and financial track record. This could present too much risk for investors.
- New businesses may struggle to attract funding due to not having a past record!
how can relying on a narrow customer base lead to business failure?
- Whilst operating in a niche market may allow you to develop a USP and differentiate yourself from your competitors, it may also mean that you’re limiting your potential customer base.
- Alternatively, some businesses may set them selves up to service a small number of large businesses.
- For example, a number of farming businesses have gone out of business because the were too reliant on contracts with supermarkets. When terms on new contracts couldn’t be agreed, due to the supermarkets squeezing margins, they didn’t have enough customers to sell their products to.
how can marketing problems lead to business failure?
- there are a range of reasons as to why businesses face problems with marketing
- product fail to satisfy customers
- inappropriate pricing structures
- too much spent on promotional campaigns
how can failure to innovate lead to business failure?
- Businesses who fail to innovate and move with consumer trends, will tend to struggle.
- Tesco.com was launched in 2000, providing food deliveries to people’s homes. They have a 28.1% share of the grocery market, yet have over 39% of online business.
- By contrast, Morrisons (11% of grocery market) who only adopted online home delivery in 2016, have less than 1% share of that market.
how can lack of business skills lead to business failure?
-Unfortunately, sometimes good inventors are not good entrepreneurs. Individuals with good technical skills, can see great products fail, as they don’t have the business acumen to make it work.
how can poor leadership lead to business failure?
- Senior managers and business leaders can ruin businesses through poor management.
- Blockbuster, Nokia, Kodak & Woolworths are but a few examples of how poor leadership and bad decision making can make even established, market leading businesses fail.
what are the external factors that could lead to business failure?
- usinesses can be impacted by issues which are out of their control, but its how they deal with those external issues that will determine their success.
- The problem is, that they have no control, so how do they manage it?
- competition
- legislative changes
- changes in consumer habits
- economic condition
- changes in market prices
how can competition lead to business failure?
- Sometimes it can be a businesses success which can lead to its downfall. If you can demonstrate that a market for a product exists, other companies will try to enter that market, taking your share.
- A competitor may come up with a design which is superior to yours, reducing demand for your product.
- Competitors may also be able to manufacture the product more efficiently, meaning they can undercut you on price. This would lead the business to decide to reduce its price, cutting its margins, or potentially lose customers.
- A lot of manufacturing businesses in the “west” have suffered as a result of cheaper products from Asia, in particular, China.
how can changes in legislation lead to business failure?
- Government legislation can have a large impact on your businesses ability to be competitive or satisfy customers.
- Many people blame the demise of a large percentage of pubs on the governments decision to ban smoking in public places. Prior to this, drink drive legislation had a similar impact.
- In more recent times, similar issues have affected the pay day loan market.
- Tax changes can also impact on a businesses ability to trade. Recent increases in Insurance Premium Tax and changes to the goods on which VAT must be charged, can impact on your competitiveness.
how can changes in consumer tastes lead to business failure?
- A business is always looking to anticipate and satisfy customers needs, but it is the anticipation which is the hardest.
- Many businesses, particularly fashion retail, are always attempting to either anticipate or influence those trends.
- However, if you get it wrong, particularly multiple times (eg Marks & Spencer’s) it could lead to failure.
how can economic conditions lead to business failure?
- It goes without saying that changes in the economy will have a large impact on a businesses success.
- In times of recession, certain “luxury” goods can see a drop in demand.
- Whilst in boom times, the sales of basic and own brand items drop as consumers have more disposable income to afford better quality goods.
How can changes in market conditions lead to business failure?
- Some businesses are more affected by changes in market prices than others.
- Oil is a product that very much impacts on all businesses. Heating, plastics, fuel and numerous other costs are governed by changes in oil prices.
- Other commodities also vary their prices regularly which can lead to businesses struggling to meet increasing costs.
what are financial factors cause business failure?
- Bankruptcy
- Insolvency
- Cash flow shortages
what non-financial factors cause business failure?
- Failure to plan; plan to fail
- Lack of experience
- Resource supply issue
- Reluctance to change or take advice
