3.5 Finance Flashcards
What is a financial objective?
A goal or target pursued by the finance department within an organisation
What are the 4 financial objectives?
Revenue,costs, profits
Cash flow
Return on investment
Cost minimisation
How would you increase revenue?
Growth, expansion, new products, advertising
How would you lower costs?
Change suppliers
Shop around
Negotiate
Save/waste less
How to increase profits ?
More revenue, lower costs
And in a recession?
Cut costs with machinery (get more effective machinery) or lower prices and add promotion schemes
What is cash flow?
The money that flows in and out of the business on a day to day business, it should be enough to pay expected bills in coming months
What is return on investment?
The financial return a company makes for investing in a project
How to calculate return on investment?
Net profit / capital invested x100
What does return on investment tell us?
A measure of the returns made from investing in the business
How good the business is at converting money invested into profit
Provides a means of comparison with other investment opportunities
How can a business reduce costs?
Minimise cost of raw materials
Reduce wage cost
Lower waste
Move to lower cost location
Delayering
How does cost minimisation benefit a business?
Keep price the same and benefit from a higher profit margin
Use cost reduction to reduce selling price an attract more customers
Why are profits important?
Provide a measure of success
Source of capital for business growth
Attract further funds from investors
What’s another word for sales revenue?
Sales turnover
What is a profit margin?
Profits as a % of its sales revenue
Profit margin = profit/SR x100
Definition of profitability ?
A relative measure comparing profits to another variable . Eg. Sales revenue to operating profit margin
What is gross profit and how do u calculate the profit margin for it?
Sales revenue - cost of sales
(Cost of sales might also be referred to as direct costs as they’re direct costs used to make/provide for goods and services )
GP/SR x100
How do you improve gross profit margins?
Need to increase the gap/ difference between sales revenue and direct costs
Increase SP
Decrease direct costs (VC)
Both
What is operating profit and how do u calculate its profit margin ?
Gross profit - fixed overheads
(Gross profit is the figure focused on by city analysts)
OP/SR x100
How to improve profit margins?
Fewer staff
Effectiveness of advertising
Reduce wastage
More production abroad
Outsourcing
What is profit for the year and how do u calculate its profit margins?
Profit after all other costs have been deducted (finance and tax)
This is the profit business has to retain for reinvestment or to pay out to shareholders as dividends.
OP- finance and tax
PFY/SR x100
What is price elasticity?
a measurement of the change in the demand for a product as a result of a change in its price.
What is contribution and what is the formula for it?
Amount of money business makes after variable cost of production has been payed
SP-VC per unit
How to calculate total contribution?
Contribution X no. Of units sold
Or
SR - total VC
What is the significance of total contribution?
If total contribution exceeds fixed costs, then the business is making a profit,
If the fixed costs exceed the contribution then the firm is making a loss
A firm will break even if the total contribution is equal to the FC
What is break even?
Level of output at which total sales revenue is equal to the total costs of production
What is break even analysis and what can it be used for?
Study of relationship between TC and TR to identify level of output at which business breaks even
A business can also use BE analysis to discover impact of changes in output on its profit levels
How do you calculate Break even?
FC/ (SP-VC)
Or
FC / Contribution
What is margin of safety?
Current/ actual sales - Break even level of sales
Amount of which sales can fall before a firm starts making a loss. Higher margin of safety the less likely it is that a loss making situation will develop
What is the need for finance? (Give me 3 reasons)
Starting Up - buy assets or pay wages or costs of materials/bills
Growth - make enough profit to reinvest into growth, or need funds to grow externally (as it may alr have been paid out to shareholders)
Other situations - cover cash flow problems, fund production of a large order
What is the best internal source of finance?
Profit
What are the two main sources of external finance?
Loan capital (overdrafts and loans) and share capital
What is a bank loan? (Give me points)
Most common way of obtaining finance
Set period of time
Has interest (fixed/variable)
Can be payed short/medium/long term installments
Is bank loan an internal or external source of finance?
External
Is bank loan short or long term source of finance?
Long term
What is an overdraft as a source of finance (give me some points)
Allows a business to be “overdrawn”
Length of time for it is usually negotiated
Usually have higher interests than normal loans
For firms that use overdraft as a way of smoothing cash variations, interest payments can be quite small
Is Overdrafts internal or external?
External
Is overdrafts short term or long term?
Short term
What is Venture capitalist as a source of finance? (Give me points)
Invest in interesting businesses with dynamic prospects
Willing to take a risk on a business
No need to repay
Dividends can be cut : flexibility
Can bring wise heads into boardroom
Are Venture capitalist and external or internal source?
External
Are venture capitalist short term or long term?
Can be either
What is retained profit?
No associated costs
No interest charges
May be too little profit to allow business to grow to its full capability
Is retained profit internal or external source of finance?
Internal
Is retained profit long term or short term?
Long term
What is share capital as a source of finance?
No need to repay
Flexibility in cutting dividends
May be hard to raise
Can dilute ownership
Great for growing/starting up businesses
Is share capital and internal or external source of finance?
External
Is share capital short term or long term source of finance?
Short term
What is trade credit as a source of finance?
Simplest form of external financing
Businesses obtains goods/services from another business but does not pay back immediately
Avg credit period is 2 months
Good way of boosting day to day finance
However other businesses may be hesitant or reluctant to pay with other businesses if they do not get paid in good time
Is trade credit internal or external source of finance?
External
Is trade credit short term or long term?
Short term
What is Debt factoring?
Selling goods on credit - can arrange that it’s bank take over the invoicing, giving seller 80% of the value of the sale immediately, then collecting payment from customer
Bank hands over retaining sum to seller (usually 16%) so seller has most of cash immediately
Received about 96% of sale
Bank only gets 4% for itself
Is debt factoring internal or external source of finance?
Internal
Is debt factoring short term or long term?
Short term
What is crowdfunding as a source of finance?
Looks for many small investors
Invest an avg of £100 (so need £500 to start up)
However more of crowdfunded with a small fund could be an administrative nightmare
Good for locality
Creates PR
Credit score isn’t required
Less risk
Is crowdfunding a short term or long term source of finance?
Long term
Is crowdfunding internal or external?
External
What is crowdfunding used for?
Growth
What is debt factoring used for?
Just a way of finance for cash flow
What is trade credit used for?
Stock
What is share capital used for?
Growth
What is retained profit used for?
Stock
What is a venture capitalist used for?
Growth
What is an overdraft used for?
Expenses
What is a bank loan used for?
Growth
What factors affect break even output?
Changes to SP
Changes to VC
Changes to FC
What is a budget?
An agreed financial plan for the future concerning the revenues and costs of a business.
A budget serves as a guideline for financial management and planning.
What is an Income Budget?
The agreed, planned income of a business (or division of a business) over a period of time.
It may also be described as a revenue budget or a sales budget.
What is a Profit Budget?
The agreed, planned profit of a business (or division of a business) over a period of time.
This budget focuses on the expected profitability of the business.
What is one key point about the Income Budget?
It links to the targets of a business.
This connection helps ensure that the income goals align with the overall objectives of the business.
How is the Income Budget subdivided?
Into different elements to allow analysis of different sources, particularly in multi-product firms.
This subdivision aids in understanding the contribution of various products to overall income.
What does the Income Budget help a business to assess?
Expenditure needs, especially raw materials.
This assessment is crucial for managing costs and ensuring efficient operations.
What additional sources of income are included in the Income Budget?
Other sources of income, such as rent received.
Including these sources provides a more comprehensive view of the business’s income.
What is the expenditure budget?
A financial plan that outlines the expected expenditures of a business over a specific period
True or False: The expenditure budget is simpler than the income budget.
False
List three items typically included in a business’s expenditure budget.
- Labour costs
- Marketing expenditure
- Administration costs
Fill in the blank: The expenditure budget can include _______ costs.
[capital]
What are ‘mass components’ in the context of an expenditure budget?
Items or materials required for production or service delivery
What type of costs does marketing expenditure refer to?
Costs associated with promoting and advertising the business’s products or services
What do administration costs encompass?
Expenses related to the general operation and management of a business
Identify a category of expenditure that involves significant upfront investment.
Capital costs
True or False: The expenditure budget includes only direct costs.
False
How is the profit budget calculated?
Profit = income - expenditure
This formula is used to determine the budgeted profit.
Fill in the blank: The total expenditure is calculated by adding raw materials, labour costs, and _______.
administration and other costs
This includes all types of expenses incurred.
What is zero budgeting?
No expenditure budget is set; all departments must request and justify all spending.
Zero budgeting requires a fresh start each budgeting period, rather than adjusting previous budgets.
What is one method of setting a budget based on company performance?
Setting the budget as a percentage of sales revenue.
This method ties budget allocation directly to sales performance, making it more dynamic.
What is a common reason for setting budgets?
To ensure that a business does not overspend.
Budgets act as financial controls to manage costs effectively.
Name a method of budgeting that involves historical data.
Budgeting according to last year’s budget allocation.
This method typically includes minor adjustments for inflation and other factors.
What is one benefit of setting a budget related to staff management?
To encourage delegation and responsibility.
Budgets help in motivating staff by providing clear financial targets.
Fill in the blank: Budgeting may also involve _______ and knowledge of the industry/market.
past experience
This can include significant levels of market research or educated guesses in new business contexts.
What is a reason for setting budgets related to business priorities?
To establish priorities.
Budgets help in aligning resources with the most critical areas of the business.
What is one way budgeting improves operational performance?
To improve efficiency.
Efficient budgeting processes can lead to better resource allocation and productivity.
True or False: Budgeting can motivate staff.
True.
Motivating staff is one of the key reasons for setting budgets.
What is the purpose of gaining financial support through budgeting?
To provide a structured financial plan that can attract investment or loans.
A well-prepared budget can demonstrate financial viability to stakeholders.
What is a common problem with setting budgets?
Higher level managers not knowing enough about the division or department
This can lead to unrealistic budget expectations.
What is a challenge in gathering information for budget setting?
Difficulties in gathering information on sales and other metrics
Accurate data is crucial for effective budget planning.
What type of changes can complicate budget setting?
Unforeseen changes
These changes can impact both revenues and expenses.
What makes price changes difficult to forecast in budgeting?
Changes in prices that are difficult to foresee
This can affect cost projections and overall budget accuracy.
What issue arises from budgets being imposed from above?
Problems arising from budgets being imposed
This can lead to a lack of ownership and motivation among lower-level managers.
What is a drawback related to the time involved in budget setting?
The time taken in setting budgets
Extended budget-setting processes can delay decision-making.
What can happen to departments if they feel budget processes are imposed?
Departments might be demotivated and unhappy
This can negatively affect morale and productivity.
What is the formula for calculating variance?
Variance = difference between budgeted and actual figure
This helps in assessing budget performance.
What is variance analysis?
The comparison by an organisation of its actual performance with its expected budgeted performance over a certain period of time
It is a key tool for financial control and management.
How can we improve cash flow?
Leasebacks
Effective credit control (chasing up receivables)
Debt factoring
Hold less stock
Take out loan
Overdraft (doesn’t improve but solves problem)
How do you analyse a cash flow forecast 1?
Look at closing balance and compare to opening
What do declining / positive cash flow forecast figures mean?
If figures are declining, more cash is going out than coming in and action will eventually be needed
If closing balances are bigger than inflows then situation is comfy
What do monthly cash flow forecasts help plot?
Help plot trends
There might be short term problems due to seasonality but a recovery might be apparent
What else can you look at to help analyse cash flow forecasts / what can u change from this?
Analyse receipts from receivables and payables and potentially increase receivables time period, leads to increase of inflows therefore more inflows than outflows potentially
Cash flow vs profit?
Cash flow is money flowing in and out of a business during period of time
Profit is money generated from sales after costs are paid
What distinguishes revenues from cash inflows?
Cash flows and credit sales are both revenues for the business
If TC are lower then TR then business makes profit
Hwv if receivables aren’t paid there may be CF problems
There are some inflows that aren’t revenue (eg loans)
What also counts as an outflow but not VC/FC?
If a business is expanding and buys new assets it will count as an outflow but not a VC/FC
What are 3 reasons why a business could run out of cash?
Grows too quickly(over trading) - too much cash out, additional fixed costs, cash not coming soon enough
Seasonality (a business may thrive in a season but run out cash during seasons they aren’t peaking (no sales = less inflows imbalance of outflows )
Credit periods - may be really long and u never get ur receivables and constantly have to chase them up which wastes time
Difficulties in improving cash flow?
Trade credit
If it isn’t received on time then u may delay inflows and lack inflows
Chasing it up may waste time
Sometimes trade credits cannot be negotiated
However they need to make cash flow problems subtle
What are the difficulties in improving profit?
Changing prices - depends on elasticity (could improve margins but reduce market share)
Selling more - may require additional spending on advertising
Cutting costs - quality and reliability of new suppliers or ethical issues from sourcing of products
