3.3 - Effective financial management Flashcards
What is Financial Management?
Changing monetary variables such as cash flows to achieve financial objectives such as improved cash flow.
Why is cash important?
If a business’s outflows are greater than its inflows then it could run out of cash and trading will cease.
What are the 5 main ways of improving Cash OUTFLOWS (i.e. decreasing it) ?
- Delay paying invoices
- Leasing rather than buying
- Reduce stock orders.
- Improve credit terms with suppliers.
- Use cheaper suppliers.
What are the 5 main ways of improving Cash INFLOWS?
- Increasing sales revenue.
- Destocking.
- Reduce credit terms with customers.
- Encourage customers to pay early (incentives).
- Use short-term sources of finance, e.g. overdrafts and short-term loans.
What can profit-improving techniques do to a business?
It can affect the performance of a business and in the long term, this could reduce profits.
What are the 5 profit-improving techniques and what are its consequences (outcomes) ?
- Cutting material costs - Lower quality products
- Cutting labour costs - lower motivation of workforce
- Cutting investment - damages long-term competitiveness
- Improve products - expensive development costs
- Increase prices - customers switch to competitor’s products
What are the 2 main areas that a business can focus on to improve profit?
- Increasing revenue
2. Lowering costs
What is the formula for Total Revenue?
Total Revenue = Number of Products Sold x Average Price
What 3 methods can a business perform to increase revenue?
- Improved marketing
- Better products
- Increasing its selling price.
What is the impact of a business increasing its selling price?
The impact an increase in price has on revenue depends on how sensitive demand is to a change in price.
What is the formula for Total Costs?
Total Costs = Fixed Costs + Variable Costs
What are the 2 main ways in which a business could reduce its costs?
- Cutting costs of raw materials, labour or research and development costs.
- Cutting its marketing
What are Variable Costs?
Costs that change directly with the number of products made.
e.g. materials
What is the Break-Even Point?
The point where total costs is equal to the total revenue, thus equalling to ZERO profit.
How can you locate the B/E point on a graph?
The point on the graph where total costs and revenue meet.
On a B/E chart, how can you indicate that a business is making a profit/loss?
When TOTAL REVENUE is above the break even point.
When TOTAL REVENUE is below, it makes a loss.
What is Fixed Costs?
Costs that do not change at any level of output.
e.g. rent
How can you indicate a line of FIXED Costs on a B/E chart?
A horizontal line.
What is ‘Total Costs’ ?
The sum of all the costs at any level of output.
What is Total Revenue?
The amount of money earned by a business from selling products. It increases directly with the number of products sold.
What is the formula for Break-Even?
Break even = Fixed Costs / Contribution
What is the formula for Contribution?
Contribution = Revenue - Variable Costs
What is the Margin of Safety?
The difference between the number of units of planned or actual sales and the number of units of sales at break even point.
What can the Margin of Safety indicate?
How much production could fall before the business starts to make a loss.
What is Break-Even analysis?
A useful tool to help a business make decisions and set targets, and plan for the future.
In detail, what can Break-Even analysis enable a business to do?
It answers ‘what if’ questions, e.g. what would be the impact of an increase in variable costs on profit? An increase in fixed or variable costs is likely to lower the break-even point. An increase in price will also lower the number of units required to break even.
What can Break Even analysis do in terms of the B/E point?
Break-even analysis can identify strategies for lowering the break-even point and increasing profit.
When might a business use break-even analysis?
- Understanding the past
- Setting and achieving production targets
- Launching a new product
- Starting a new business
- Developing a business plan
What are the two sources of funds to finance growth?
- INTERNAL (from within a business)
2. EXTERNAL (from outside a business)
What are the 4 types of ‘borrowing’ EXTERNAL sources of finance?
- Overdraft
- Loans
- Bonds
- Trade Credit
What are 2 types of Stock Market Flotations of EXTERNAL Sources of finance?
- Private Limited Companies (LTD)
2. Public Limited Companies (PLC)
What are 3 types of Internal Sources of finance?
- Owner’s funds
- Retained profit
- Asset Sales
What are three factors when comparing sources of finance?
- RISK - Selling shares may mean owners lose control.
- COST - The cost of borrowing varies across different sources.
- AVAILABILITY - Some sources, such as loan or share capital, might not be accessible.
What are 5 questions to consider when choosing sources of finance?
- Is it a short term or long-term requirement?
- How much finance is required?
- If we borrow it how much will it cost (interest rate %)
- What sources are available to our business?
- What level of debt can we manage?
What are 3 advantages of Break-Even analysis for a small business?
- Illustrates the importance of a start-up, keeping fixed costs down to a minimum.
- Helps a business understand the level of risk involved in a start-up
- Focuses the business on how long it will take to reach profitability
What are 3 disadvantages of Break-Even analysis for a small business?
- Unrealistic assumptions (products are not sold at the same price at different output levels)
- Sales are unlikely to be the same as output
- Variable costs do not stay the same.
