3.5 Financial Management Flashcards
What is a financial objective ?
Refers to the monetary goals/targets a business will set itself during a certain period of time
Value of setting financial objectives ?
- act as a measure of performance
- provide targets that can motivate
- potential investors/creditors may be able to assess the viability of the business
Define cost minimisation
The process by which businesses attempt to maximise profits by keeping costs low
Define revenue targets
Involves setting minimum levels of revenue
Any objective set would have to be co-ordinated with other functional areas
Define profit targets
Involves setting a satisfactory level of profit that the company would be happy achieving
Define return on investment
A business might set itself an objective in terms of the return on an investment
Calculation for return on investment ?
Return on investment (profit) / capital invested x 100
Define capital structure
Refers to the long term finance of the business made up of equity (share capital) and borrowing (loan capital)
Internal influences on capital structure ?
- owners + their motive
- industry sector + current financial position of the business
External influences on capital structure ?
- economic factors
- political/government policy
- competition
Why do businesses need finance ?
- start up funds
- running costs
- growth and expansion
Internal sources of finance ?
- owners saving
- retained profit
- reducing levels of stock
- sale of existing assets
External sources of finance
(Short term) ?
- overdraft
- trade credit
- debt factoring
External sources of finance
(Long term)?
- share capital
- government grants
- loans
- crowdfunding
- venture capitalist
Define overdraft
Service that lets you have money even if there is none available in your current account
For an agreed amount of money and an agreed period of time
Define trade credit
Where a business will allow customers a period of time to pay for their goods or services.
Buy now pay later
Define debt factoring
Where a business sells outstanding customer debts to a 3rd party company who chase + collect payments.
The business gets a one off payment upfront.
Define bank loan
A loan for an agreed period of time at a fixed rate of interest to be repaid in monthly instalments
Define venture capitalist
Business invests in new start-up companies
in return they get some ownership of the company
Define equity
Also known as share capital
This is raised when a business sells shares in return for a % of the business. The business will need to pay dividends to shareholders
Define crowdfunding
An entrepreneur or business can attract a ‘crowd’ of investors - each of whom takes a small stake by contributing towards an online fundraising target
Advantage & disadvantage:
Bank loan
Adv:
- can spread large amounts over smaller more manageable payments
Disadv:
- interest
- often a number of T&C’s
- fees for late repayments
Advantage & disadvantage:
Overdraft
Adv:
- flexible
- no interest if paid on time
Disadv:
- high charges if you miss payment deadlines
Advantage & disadvantage:
Venture capitalist
Adv:
- large amounts
- no debt repayments
Disadv:
- can lose control of ownership
- dividends
Advantage & disadvantage:
Share capital
Adv:
- large amounts
- no debt repayments
Disadv:
- can lose control of ownership
- dividends
Advantage & disadvantage:
Trade credit
Adv:
- flexible
- no interest if paid on time
Disadv:
- high cost if not paid on time
- fees attached
Advantage & disadvantage:
debt factoring
adv:
- large amounts upfront
- all the money can be accessed straight away
disadvantage:
- could potentially have a negative image on the business if 3rd party is not ethical in collecting debt
Advantage & disadvantage:
crowdfunding
adv:
- no debt repayments
- good PR for the business
disadvantage:
- can lose some equity depending on terms of deal
- might be limited
Advantage & disadvantage:
government grants
adv:
- does not need to be repaid
- no interest or repayment
disadvantage:
- limited availability
what factors will influence the choice of finance?
- time; short term/long term
- finance available in the business
- what the money is needed for
define a budget
a forward financial plan that covers all the aspects of a businesses costs and revenues
why prepare a budget?
- to exercise financial control
- can provide direction & co-ordination
- to ensure that no department has an overspend
what are variances?
(budget)
the variance is the difference between actual and the budget
define a favourable variance
better than expected:
- costs lower than expected
- revenue higher than expected
define an adverse variance
worse than expected:
- costs higher than expected
- revenue lower than expected
budget allocation:
what does the level of expenditure depend on?
- amount available
- inflation
- external factors
define zero budgeting
where budget costs + revenues are set to zero
budget is based on new proposals for cost and sales
time consuming but starting from scratch = ensure that funds are allocated in the right way
define historical budgeting
use last years figures and add a little for inflation
quicker + simpler but may not focus on problem areas of the business —–> doesn’t encourage efficiency
benefits of budgeting?
- effective way to control + monitor costs
- can be used as a motivational tool
- inefficiency and waste can be identified
drawbacks of budgeting?
- budgets = based on assumptions and are not an exact tool
- time consuming
- can be demoralising if set incorrectly
define cash flow
the movement of money in and out of a business over a period of time
define cash flow forecast
the projection of money moving in and out of the business over a given period of time
what can poor cash flow lead to?
- unable to pay bills
- poor reputation
- lack of future financial options
how to improve a cash flow?
- use a source of finance
- sale and leaseback
- cut costs
how to work out net cash flow?
inflows - outflows
purpose of cash flow?
identify problems in advance
define break even
the point at which total revenue equals total costs
what does break even analysis help with?
helps a business to make decisions about prices, costs and the level of sales
define total revenue
(sales)
amount of money business receives from selling its goods
total revenue equation?
price per product x quantity sold
define fixed costs
costs that do not change as output changes
define variable costs
costs that change as output changes e.g material costs
how to work out total costs?
fixed costs + variable costs
define margin of safety
the difference between the current output and the break even point
how to work out margin of safety?
current output - break even
break even formula?
fixed costs / selling price per unit - variable cost per unit
total contribution formula?
(selling price - variable cost) x output
profit/loss calculation?
total contribution - fixed costs
why can cash flow problems occur?
- poor management
- high costs
- over-trading
how can we improve a cash flow?
- use a source of finance
- debt factoring
- sale and leaseback
define sale and leaseback
when a business sells one of its assets and will then rent it back
provides a short term boost to the cash flow but can have a negative impact on profitability
difference between revenue and profits?
revenue is the money made from sales whereas profits is calculated by deducting costs + expenses from revenue
define profitability
profitability is a measure against revenue
can be effective in making comparisons over time
how can a business improve profitability?
- cut material costs
- source cheaper suppliers
- reduce overheads
potential issues of improving cashflow?
- debt repayments
- lower long term profits
- credit rating issues
potential issues of improving profitability?
- quality issues
- de-motivated workers
Define a balance sheet
A financial document that summarises the net worth of a business
It balances total assets with total equity and liabilities
Define a debtor
Someone who owes the business money e.g a customer
What are trade receivables ?
Amounts owed by debtors to the business
(Money coming into the business)
What is a creditor?
Someone the business owes money to e.g supplier
Define trade payables
The amount a business owes to its creditors
Define inventories
Stocks
What is total equity ?
The total amount of money pumped into a business either from retained profit or share capital
Define non-current assets
Fixed assets e.g premises and vehicles which are likely to be kept for at least a year
Define current assets
Expected to vary in value on a daily basis e.g stock or cash
What are current liabilities ?
Payments that need paying within a year e.g creditors
What are net current liabilities ?
Current assets minus current liabilities
Define non-current liabilities
Debts that will take more than 1 year to pay e.g long term bank loans
Define depreciation
Accounting technique which allows a business to show a true reflection of an assets value
