2.3 Managing Finance Flashcards
What are the 2 types of financial statements
Statement of comprehensive income (profit and loss)
Statement of financial position (balance sheet)
What can you find from a statement of comprehensive income
Changes in sales revenue
Changes in the direct costs of sales
How well a business is managing its operating costs
The profitability of a business
Unusual incomes/ expenses during the year
In a statement of comprehensive income what is the revenue/ turnover
Income from sales
Quantity sold x price
In a statement of comprehensive income what is cost of sales
Costs that are directly associated with making the product eg raw materials
In a statement of comprehensive income what is gross profit ( definition and calculation)
Difference between revenue and the cost of sales. It shows the profit made of the trading activity before any other costs are taken into account
Revenue - cost of sales
In a statement of comprehensive income what are selling expenses and admin expenses known as
Operating costs
In a statement of comprehensive income what is operating profit (definition and calculation)
Takes into account the other operating expenses on top of gross profit
Gross profit - selling expenses and admin expenses (operating costs) (other operating expenses)
In a statement of comprehensive income what is interest
If the business has borrowed any cash from external sources of finance
In a statement of comprehensive income what is profit for the year (net profit) (definition and calculation)
The actual profit the business has made
Operating profit - interest
In a statement of comprehensive income what is taxation
Money that the business owes to the government
In a statement of comprehensive income what is profit for the year (net profit) after tax (calculation)
Profit for the year - taxation
How do you measure profitability
The info in the statement of comprehensive income can show how well the business is performing
It’s possible to measure through calculating profit margins as they measure the size of profit in relation to revenue/ turnover
What’s gross profit margin and how is it calculated
Shows the gross profit made on sales turnover/ revenue
Gpm= gross profit margin
—————————— X 100
Revenue
Why are higher gross profit margins favourable to low ones
It means that more gross profit is being made per £1 of sales
How do you increase the gross profit margin
Raising revenue/ turnover relative to the cost of sales by increasing price
By cutting the cost of sales which may be achieved through funding cheaper suppliers of key materials
Why does the gross profit margin vary between industries
The quicker the turnover of inventory, the lower the gross profit margin that is needed
Eg a supermarket with a fast stock turnover is likely to have a lower gross profit margin than a car retailer with a slower stock turnover
Therefore some supermarkets are very successful with low gross profit margins
What’s the operating profit margin and how is it calculated
Shows the operating profit made on sales revenue/ turnover
It’s used to measure a company’s pricing strategy and operating efficiency
It gives an idea of how much a company makes (before taxes and interest) on each pound of sales
Opm = operating profit
————————— X 100
Revenue
Why is a high operating profit margin preferred
Because more money is made on each £1 of sales
If the opm is increasing, the company is earning more per pound of sales
What’s profit for the year margin (net profit) and how is calculated
It takes into account all business costs including interest, other non- operating costs and exceptional items
It’s also usually calculated after tax has been deducted
Npm = net profit before tax
——————————— X 100
Revenue
Why are higher net profit margins usually better
Because it is the final amount of profit left over for the owners
The net profit margin focuses on the ‘bottom line’ in business which refers to the bottom line in the statement of comprehensive income which shows the profit left after all deductions have been made
How can you increase revenue
Increase prices
Reduce processes (dependent on PED)
Create awareness and desire through marketing
Add value to the product - increase benefits and features
Why are some businesses unprofitable
No demand
Selling at wrong price
Low contribution per unit
Poor management of costs
Expansion of business
How can you increase profit
Increase revenue
Decrease costs
How to decrease costs
Reduce production costs
Improve efficiency
Use capacity more fully
Eliminate unprofitable processes- such as unprofitable lines
Reduce variable costs- negotiate better deals with suppliers
Lower overheads- move to a cheaper location
What’s the difference between cash and profit
Profit is an absolute position when all costs have been deducted from revenue
Cash flow is an ongoing concern
In order to reach a position of profit a business must manage cash flow so it can pay expenses and running costs
A business cannot be profitable unless it effectively manages cash flow
What is a statement of financial position (balance sheet)
Normally produced at the end of the financial year
It’s like a photograph of the financial position of a business at a particular point in time
It provides a summary of its assets, liabilities and capital
In a statement of financial position what are assets
Resources owned by a business
Capital + liabilities
In a statement of financial position what are liabilities
Debts of the business
They are a source of fund for a business and may be short term (overdraft) or long term (mortgage)
In a statement of financial position what will be equal
The value of assets will be equal to the value of liabilities and capital
In a statement of financial position what is capital
The money put into the business by the owners
It’s used to buy assets
What are non current assets
Long term resources that the business will use repeatedly. They may be called fixed assets
Eg land, property
What are current assets
Will be changed into cash within 12 months
They are called liquid assets
Eg inventories (stocks of raw materials, components and finished goods), trade and other receivables (debtors) (money owed to a business), cash or cash equivalents (money held in bank accounts)
What’s the liquidity of an asset
The liquidity of an asset is how easily it can be converted into cash
What are current liabilities
Any money owed by a business that must be repaid within a year
Eg loan and borrowings, trade and other payables (money owed by the business to suppliers of raw materials), components aka trade creditors, current tax liabilities ( employees income tax, VAT, corporation tax)
What are non current liabilities
Long term loans and any other money owed by the business that doesn’t have to be repaid for Atleast a year
How to calculate net assets
Total assets - total liabilities
What’s shareholders equity
Summary of what is owed to the owners of the business.
Share capital and retained earnings (retained profit) are common examples
How can you measure liquidity
Current ratio
Acid test ratio
What’s current ratio and how is it calculated
A liquidity ratio and focuses on the current assets and current liabilities of a business
Current ratio= current assets
————————
Current liabilities
What will the current ratio be between if the business is regarded as having sufficient liquid resources
Between 1.5:1 and 2:1
This is like saying the business has £2 of current assets for every £1 of current liabilities
What will the current ratio be if the business is over borrowing or over trading
Below 1
What would it mean to operate at a current ratio above 2:1
It may suggest that too much money is tied up in stocks
What is acid test ratio and how is it calculated
A more severe test of liquidity because inventories are not treated as liquid resources
There’s no guarantee that stocks can be sold and they may become obsolete or deteriorate. They are therefore excluded from current assets when calculating the ratio
Acid test ratio= current assets- inventories
——————————————-
Current liabilities
What does it mean if a business has an acid test ratio of less than 1:1
It means that it’s current assets minus stocks don’t cover its current liabilities
This could indicate a potential problem
It varies for different industries
What’s working capital (circulating capital) and how is it calculated
The amount of money needed to pay for the day to day trading of a business
A business needs working capital to pay expenses such as wages, electricity and gas charges
The working capital of a business is the amount left over after all current debts have been paid
It is:
- the relatively liquid assets of a business that can easily be turned into cash
- the money owed by a business which needs to be paid in the short term
Working capital= current assets- current liabilities
What does it mean if a business has low levels of working capital
It may be struggling or threatened with closure
How can you manage working capital
Size of business - sales typically generate a need for stocks, trade credit and cash. Hence the larger the business, the larger the amount of working capital there is likely to be
Stock level- businesses is different industries have different needs for stocks. Businesses which are able to adopt JIT techniques will carry lower stocks. The more stocks a business needs the higher it’s working capital will be, all other things being equal
Debtors and creditors- the time between buying stock financed by trade credit and selling finished products can influence levels of working capital. Few businesses are fortunate enough to be able to operate with negative working capital. Typical businesses need around twice the amount of current assets as current liabilities to operate safely
How can you maintain adequate levels of working capital
- if they keep too little( current assets are too low and current liabilities are too high) they’ll start to encounter trading problems
- if a business does not count enough stocks of raw materials, it could find that production is halted when it runs out of stock. If it doesn’t carry enough finished stock it may be unable to fulfil orders on time
- if there’s not enough cash in the business it may not be able to pay its bills on time
- if it had borrowed too much through trade credit, it may be unable to pay invoices
How do you calculate total assets
Non current assets + current assets
How do you calculate total liabilities
Current liabilities + non current liabilities
How to calculate net assets
Total assets - total liabilities
What’s total equity on a balance sheet and how to calculate it
Total money invested into the business
Share capital + retained earnings
What are net assets always the same as
The same as total equity and if they’re not the same the balance sheet has been done incorrectly
On a balance sheet what are intangible assets
Brand name, worth of brand
On a balance sheet what are cash and cash equivalents
Physical money
What are the internal causes of business failure
Lack of planning
Lack of funds
Cash flow problems
Explain the internal cause of business failure - lack of planning
At the start up stage, entrepreneurs can be prone to overlook the importance of planning. A thorough business plan is needed to provide a clear vision for the future so that owners can take an objective and critical look at the whole business idea
A plan will provide a roadmap that shows clear direction for the development of the business and help to identify potential problems in advance so that the business is better prepared to deal with them
Financial planning is crucial and entrepreneues need to ensure that the business is sufficiently funded to cope with weak cash flow in the initial stages
Explain the internal cause of business failure- cash flow problems
There are a number of reasons why a business may run out of cash: Over trading Investing too much in fixed assets Allowing too much credit Overborrowing Seasonal factors Unforeseen expenditure External factors Poor finance management
Explain the internal cause of business failure- lack of funds
Some businesses fail because they cannot attract funding. A lack of funding can affect both established businesses and new businesses
Established businesses may fail to attract funding because their track record is not as good as it needs to be. As a result they present too much of a risk for investors and other lenders
New businesses often struggle to attract funding because they don’t have a trading history and they’re too risky for investors
What are the external factors causing business failure
Competition- a new competitor or an overcrowded market can lead to a shortage of demand and falling sales
Legislation- new legislation can often mean increased costs as a business adjusts its products and processes to comply
Market conditions- for example changes in commodity prices or consumer tastes
Economic factors- the business cycle
