3- Business Finance Flashcards
The needs for funds
- SHORT-TERM NEEDS
- LONG-TERM NEEDS
- START-UP CAPITAL
- EXPANSION
SHORT-TERM NEEDS
Once a business starts trading it will earn revenue. This money can be used
to meet the costs of the business .
sometimes the revenue may not cover all expenditure. So the business will need to borrow money, it called short-term finance; this is because it is usually repaid within one year.
LONG-TERM NEEDS
Businesses often raise money and take much longer than one year to repay what is owed. This is called long-term finance.
Some long-term finance comes from the owners. This is called capital
START-UP CAPITAL
Funds are most needed when first setting up a business.
EXPANSION
Once a business is established, the owners often want to expand.
INTERNAL SOURCES OF FINANCE
- PERSONAL SAVINGS
- RETAINED PROFIT: profit held by a business rather than returning it to the owners and which may be used in the future
- SELLING ASSETS: An established business may be able to sell some unwanted assets to raise finance. For example, machinery, land and buildings
EXTERNAL SOURCES OF FINANCE
finance obtained from outside the business
The main sources of short-term finance
- bank overdraft : agreement with a bank where a business spends more money than it has in its account (up to an agreed limit)
- trade payables : buying resources from suppliers, such as raw materials and components, and paying for them at a later date, usually within 30 to 90 days.
- credit cards : are popular because they are convenient, flexible and avoid interest charges if accounts are settled within the credit period.
some examples of long-term finance
- LOAN CAPITAL: The amount borrowed, and interest, must be repaid in regular instalments over a fixed period.
- Unsecured bank loans: Some businesses may find it difficult to get an unsecured bank loan. This is because they present too much risk for banks. Interest rates are higher for unsecured loans compared to secured loans.
- Mortgages : A mortgage is a long-term loan and the borrower must use land or property as security.
- Debenture: long-term security yielding a fixed rate of interest, issued by a company and secured against assets
- HIRE PURCHASE : buying specific goods with a loan, often provided by afinance house
- SHARE CAPITAL : share capital is an important source of external finance.
The sale of shares can raise very large amounts of money. - VENTURE CAPITAL: specialist investors (individuals or companies) who provide money for business purposes, often to new businesses
- CROWD FUNDING : where a large number of individuals (the crowd) invest in a business venture using an online platform and therefore avoiding using a bank
THE IMPORTANCE OF CASH
- TO PAY SUPPLIERS, OVERHEADS AND EMPLOYEES: Abusiness always needs cash to pay important bills, Businesses also need cash to pay for overheads, such as rent, electricity, insurance and telephone charges.
- TO PREVENT BUSINESS FAILURE: If a business runs out of cash, it may become insolvent. This means that the business cannot pay its debts. This would usually result in the business closing down.
cash flow forecast
prediction of all expected receipts and expenses of a business over a future time period, which shows the expected cash balance at the end of each month
cash inflow
flow of money into abusiness
cash outflow
flow of money out of a business
NET CASH FLOW
The difference between cash inflows and cash outflows
closing cash balance
amount of cash that the business expects ot have at the end of each month (takes into account the cash inflows and cash outflows)
WHY ARE CASH FLOW FORECASTS IMPORTANT?
- IDENTIFYING CASH SHORTAGES
- SUPPORTING APPLICATIONS FOR FUNDING
- HELP WHEN PLANNING THE BUSINESS
- MONITORING CASH FLOW
fixed costs
costs that do not vary with the level of output
variable costs
costs that change when output levels change
total costs
fixed cost and variable cost added together
total revenue
money generated from the sale of output. It is price multiplied by quantity
break-even point
level of output where total costs and total revenue are exactly the same: neither aprofit nor aloss is made
break-even chart
graph that shows total cost and total revenue; break-even point is where total cost and total revenue intersect
margin of safety
amount of output available to be sold above the break-even point where the business makes a profit
statement of comprehensive income
financial document showing a firm’s income and expenditure in a particular time period
profit
money left over after all costs have been subtracted from revenue
gross profit
sales revenue subtract cost of sales
operating profit
gross profit less expenses
distributed profit
profit that is returned ot the owners of abusiness
retained profit
profit held by abusiness rather than returning it to the owners and which may be used in the future
dividend
share of the profit paid to shareholders in acompany
THE STATEMENT OF COMPREHENSIVE INCOME
It shows the income and expenses of a business during the financial year.
What does the statement of comprehensive income contain?
- Revenue : is the money the business receives from selling goods and services. Revenue must not include VAT.
- cost of sales : would include costs such as raw materials and the wages of factory workers.
- Gross profit : is calculated when the cost of sales is subtracted from the
revenue. This is the profit made before the subtraction of general expenses or overheads. - Administrative expenses : are the general overheads or expenses of the business.
- other operating expenses : Any expenses not included in administrative expenses.
- Selling expenses : business may incur a range of expenses that are directly related to the selling of its products.
- Operating profit : is the profit generated from the firm’s main activities. It does not include any income from financial investments made by the business.
- Finance cost : interest paid on loans.
- Profit for the year : it is the cost of finance is subtracted from the operating profit, This is the profit before taxation.
- Profit for the year after taxation: This is the amount of money that is left over after all expenses, including taxation, have been subtracted from revenue.
HOW MIGHT THE STATEMENT OF COMPREHENSIVE INCOME BE USED IN DECISION MAKING?
- INVESTMENT DECISIONS
- COST ANALYSIS
- BASIS FOR FUTURE FORECASTS
- MAKING COMPARISONS
normal profit
minimum profit a business needs to make to retain the interest of the owner(s)
statement of financial position
summary at a point in time of business assets, liabilities and capital (often called the balance sheet)
liabilities
debts of the business, which provide a source of funds
capital
finance provided by the owners of the business
non-current assets
assets that last for more than one year
current assets
assets likely to be changed into cash within a year
liquidity
ease or speed with which assets can be sold for cash
trade receivables
amounts of money that are owed to a company by its customers
current liabilities
debts that have to be
repaid within a year
net current assets
current assets minus current liabilities, also known as working capital
non-current liabilities
debts that are payable after 12 months
net assets
value of all assets less the value of all liabilities; total at the botom of the first part of the balance sheet
goodwill
value that acompany has because it has a good relationship with its customers and suppliers
ratio analysis
mathematical approach to investigating accounts by comparing two related figures
Profitability ratios
measure the performance of the business and focus on profit, revenue and the amount invested in the business.
Liquidity ratios
measure how easily a business can pay its short-term debts, such as wages or suppliers.
gross profit margin
(or mark-up) gross profit expressed as apercentage of turnover
operating profit margin
operating profit expressed as a percentage of turnover
current ratio
assesses the firm’s liquidity yb dividing curent liabilities into curent assets
acid test ratio
similar to the current ratio but excludes stocks from current assets (sometimes caled the quick ratio)
return on capital employed (ROCE)
profit of abusiness as apercentage of the total amount of money used to generate it
USING RATIOS TO MAKE COMPARISONS
- Ratios can be used to assess the performance and the liquidity of a business at a particular point in time.
- They can also be used to monitor the progress of a business over time.
- Ratios can also be used to make comparisons between businesses in the same industry.
USING FINANCIAL DOCUMENTS TO INFORM DECISION MAKING
- FUNDING DECISIONS
- REDUCING COSTS
- INCREASING PROFITABILITY
- INVESTMENT DECISIONS
OTHER USERS OF FINANCIAL DOCUMENTS
- GOVERNMENT
- COMPETITORS
- THE MEDIA
- TAX AUTHORITIES
- AUDITORS
- REGISTRAR OF COMPANIES
WHO WILL USING FINANCIAL DOCUMENTS TO ASSESS THE PERFORMANCE OF ABUSINESS?
- Managers : will want to assess the performance of the company. Managers might also make comparisons with competitors to see how their performance compares with that of rivals. Managers might be more motivated if they see that their company is performing better.
- Employees : might need financial information during wage negotiations. Information about profit and the prospects of the business could be used to decide whether it can afford to meet a wage claim.
- Owners : will be interested in the performance and the financial position of the business. For example, a sole trader might look at the profit ot see if targets have been met for the year.
- Shareholders : in limited companies will also be interested in the performance of the business. They may look at the size of dividends. And use ratio analysis to see how their investment is performing and make comparisons with other companies in which they could invest.
- Banks : need up-to-date financial information when deciding whether to
lend money to a business. and to see whether a business can repay the loan with interest. They will tend to focus on the amount of working capital a business has and whether it already has any large debts. - Suppliers will want to assess the creditworthiness of businesses that buy
resources from them using trade credit. Asupplier is likely to carry out a credit search before granting such credit. Suppliers : can use accounts to see whether new customers are a good risk. And to access to financial information to look at the firm’s ability to pay its debts
before making any deliveries.
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