2.4 Making Financial Decisions Flashcards
2.4.1
Business Calculations
Sales Revenue
- Sales revenue is:
○ how much a business receives in payment from selling goods and services
○ also called ‘income’, ‘revenue’ or ‘turnover’. - A business needs to know how much revenue it has received to be able to calculate profit (once costs are deducted).
- The formula for sales revenue is: selling price x quantity sold
Costs
- Costs are the operating expenses a business must pay.
- A business needs to know how much its costs are to be able to calculate profit (after deducting costs from sales revenue).
- Different types of costs: fixed costs, variable costs and total costs.
Fixed Costs
- Stay the same regardless of output
- Are indirect costs (not directly linked with the production of the goods or service being produced and sold)
- Remain the same regardless of how many goods or services are made and sold
- E.g. rent, advertising, manager salaries
Variable Costs
- Change directly with the level of output
- Are usually direct costs, which are directly linked with the production of goods or services
- The more goods or services made and sold, the higher variable costs will be
- Are also known as cost of goods sold
- E.g. raw materials, raw ingredients, wages of temporary staff
Total Costs
- Are calculated by adding all fixed costs and variable costs together
What is Profit?
- Profit is the difference between how much revenue a business receives and how much it has to pay out in costs.
- Profit is difficult to make in the first year or two of operation; so a loss is often made by new businesses.
- Gross profit is the calculation of how much profit a business makes from selling goods or services after it has deducted the cost of sales (costs incurred directly).
○ The formula for gross profit is: sales revenue - cost of sales.
○ Gross profit should be expressed in units of currency, e.g. £. - Net profit is found after other operating expenses are deducted (such as fixed costs) and bank interest.
○ The formula for net profit is: gross profit - other operating expenses and interest.
○ Net profit should be expressed in units of currency, e.g. £.
Profit/Profitability
- Profit and profitability are not the same thing.
- Profit is how much profit has been made.
- Profitability looks at how good a business is at making a profit.
Profitability Ratios
Profitability ratios help a business:
- calculate its ability to make profit
- measure how effectively the business converts revenues into profit
- measure whether the profit is enough to finance reinvestment
- measure how well the business compares with the rest of the industry it operates in.
- Gross profit margin is: gross profit/sales revenue x 100. The answer should be expressed as a percentage (%).
- Gross profit margin shows how efficient a business is in converting the cost of sales bought into profit.
- The lower the gross profit margin, the more stock a business has to sell to make a sustainable profit.
- Net profit margin is: net profit/sales revenue x 100.
- When this formula is used, the answer is expressed as a percentage (%).
- Net profit margin shows how profitable a business is when all costs are taken into account.
- If the net profit margin is considerably lower than the gross profit margin, it suggests that overheads are high and should be reduced.
- The average rate of return (ARR) is: average annual profit (total profit/no. of years)/cost of investment x 100.
- When this formula is used, the answer should be expressed as a percentage (%).
- ARR calculates how much an entrepreneur or investor is getting back on the money invested and can be compared to bank interest rates.
- ARR does not take cash-flow into account.
2.4.2
Understanding Business Performance
0What is Quantitative Business Data?
- Quantitative business data is numerical and statistical data.
- Businesses use graphs and charts to present a lot of quantitative data in one place.
- Graphs, tables and charts are a visual and easy way of expressing information and can often show trends and other important considerations.
- Sometimes businesses share quantitative data in the form of numbers, such as percentages, which shows accuracy and allow for comparisons with historic figures, other businesses and the industry standard.
- Quantitative business data can be collected from primary or secondary sources:
○ primary data is collected first-hand by someone for a specific reason
○ secondary data relates to information that is second-hand
What is Financial Data?
- Financial data refers to past, present and future records of the financial health of a business, e.g. financial and accounting records, sales, marketing and salary data.
- Sharing of some financial data is mandatory, while some can remain private.
- Sole traders and partnerships have to share financial records of their income, expenses, VAT records (if they are over the VAT threshold) and Pay As You Earn (PAYE) records (if they hire staff).
- Sole traders have to keep bank statements as proof. However, this data is not shared with the public.
- Companies have to provide copies of their accounts every year and file them with Companies House; these accounts include balance sheets and statements of profit and loss, which are available for the public to view.
- Unlike sole traders and partnerships, companies must also pay auditors to prepare their accounts for them.
How can Financial Data be Used?
- Financial data can be used to:
○ show trends within a business
○ apply to a bank for a loan
○ apply to investors for investment analysis
What is Marketing Data?
- Marketing data is data that helps a business make decisions.
- It may be primary data collected by a business e.g. questionnaire about customer preferences, or it could be secondary data, which the business finds useful.
- Marketing data has information about sales forecasts, promotional plans and customer preferences.
What is Market Data?
- Market data refers to information that relates to a variety of investment markets, including:
○ live prices of stocks and shares on the stock exchange market
○ exchange rates on the currency markets show that the latest buying and selling rates for different currencies
○ commodities on the commodity market that show the price of many of life’s necessities, which can affect everyone, e.g. oil.
