3.5 Financial management Flashcards
What is the value of setting financial objectives?
Gives business a specific target in mind to complete within period of time (increase profits by 10% by end of the year), to help achieve corporate objectives, improve co-ordination between team (as have sense of purpose and direction).
Examples of financial objectives?
- revenue objectives, to increase the value or volume of sales.
- costs objectives, usually set to minimise costs (business needs to make sure doesn’t reduce quality of product or services and have ethical questions of how it operates).
- profit objectives, set target figure or a percentage increase from previous year.
What is the difference between cashflow and profit?
Cashflow is all the money flowing in and out of business over period of time, cashflow can be damaged if business has a lot of outflows of cash during period of time or if business overtrades (produces to much and have to pay suppliers and staff0 may become insolvent (unable to pay debts). Cashflow is needed to pay suppliers, wages and overheads.
Profit includes all transactions that will lead to cash in or out in the future and now.
What is gross profit and how to calculate?
Gross profit is amount left over when costs of sales is subtracted from sales revenue.
Calculated as: Gross profit = Sales revenue - cost of sales
What is Operating profit and how to calculate it?
If company’s gross profit is increasing and operating profit is decreasing, usually means the company is not controlling its costs.
Operating profit= Sales revenue - Cost of sales - Operating expenses
Profit for the year= Operating profit + Other profit - Net finance costs - Tax
What is Profit for the year and how to calculate it?
Profit for the year is the measure of profit that dividend payments are based on.
Profit for the year= Operating profit + other profit - net finance costs - tax
What is variance analysis? What is adverse and favourable variance?
A variance analysis means the business is performing either worse or better than expected.
- adverse variance is when firm performs worse than expected this may be due to costs higher than expected and revenue/profits lower than expected.
- favourable variance is when firm performs better than expected may be due to costs being lower than expected than in the budget and revenue/profits were higher than expected.
What is budgeting?
Budgeting forecasts future earnings and spending over a 12 month period, three types:
- income budget, forecasts amount of money coming into the company as revenue, in order to do this company needs to predict how much it will and at what price, managers do this using previous sales figs and market research.
- expenditure budget, predicts business’s total costs will be for the year, taking into account fc and vc, vc increase with output so managers must predict output based on sales estimate.
- profit budgeting, uses the income minus expenditure budget to calculate expect profit or loss for the year.
Value of budgeting?
Advantages:
- helps to achieve targets
- helps control income and expenditure
- helps managers review their activities and make decisions
- helps give direction and make priorities
- head of departments can delegate authority to budget holders (getting authority is motivating)
- allows departments to coordinate spending
- budgets help persuade investors business will be successful
Disadvantages:
- budgets can cause resentment and rivalry between departments having to compete for money
- can be restrictive, fixed budgets stop firms responding to changing market conditions
- time consuming to make budgets, setting and reviewing budgets may forget business’s focus on real issues (understanding consumers, winning business)
- inflation difficult to predict, prices can change by levels greater than average
- start up businesses may struggle to gather data, so budget may be inaccurate
What is break-even and how to calculate break-even output?
Break-even output is level of sales business needs to cover its costs, when total costs= total revenue.
Break even output is calculated as, fixed costs/ total contribution per unit.
What is margin of safety and how to calculate?
Margin of safety is the difference between actual output and breakeven output (actual output - breakeven output).
Margin of safety is important if business wants to make decisions, low MOS needs to increase revenue or lower costs as this would lower the BEO so it creates grater MOS, big MOS is good for firm as means less risk.
What is contribution and how do you calculate contribution per unit?
Contribution is difference between selling price of a product and the variable costs it takes to produce it.
Contribution per unit= selling price per unit - variable costs per unit.
How to calculate total contribution?
Total contribution= total revenue - total variable costs
OR contribution per unit x number of unit sold. Total contribution can be used to pay fixed costs as amount left over is profit.
What’s the value of break even analysis?
Advantages:
- easy to do
- quick, managers can see BEO and MOS immediately so can act quickly to increase sales to increase MOS or cut costs
- break-even charts allow business to forecast how variations will affect costs, revenue and profits and how variations in price and costs will affect how much they need to sell.
- break even analysis can help persuade bank to give firm a loan
- for established businesses launching new products BEA may help work out how much profit they are going to make
- break even analysis influences decisions whether new products are launched or not (if need unrealistic volume of products to break even decide not to launch new product).
Disadvantages:
- BEA assumes variable costs are always rise steadily (not always the case as business may get discounts for buying in bulk, so costs don’t go up in direct proportion to output)
-BEA is for a single product, most businesses sell lots of diff products so looking at business as a whole can be complicated.
- if data is wrong, results will be wrong
-BEA assumes business sells all its products without any wastage
-BEA only tells you how many products you need to sell to break even, not how many you will actually sell.
How to calculate gross profit margin?
Gross profit margin (%)= Gross profit/ Sales revenue x100
How to calculate operating profit margin?
Operating profit margin (%)= Operating profit/ Sales revenue x100
How to calculate profit for the year margin?
Profit for the year margin (%)= Profit for the year/ Sales revenue x100
What are cash inflows and outflows?
Cash inflows are sums of money received by the business, e.g. product sales, loans or receivables. Cash outflows are sums of money paid out by the business, e.g. to buy raw materials, pay wages or suppliers.
What is the cashflow cycle and how does it help understanding payables and receivables?
Cashflow cycle is delay between money going out and coming into the business. The length of this depends on: type of product (determines how long it takes to produce and held in stock), credit payments (buying on credit means the goods are received but buyer has to agree on credit period) . People who are owed money are creditors, money owed is known as payables, people that owe money to business are known as debtors (customers) and money owed to business is known as receivables. Ideal cashflow situation is where there’s short period of time from start of production to sales of goods and where business is given longer credit period by creditors than it gives its debtors.
How to improve cashflow?
- overdrafts
- business holding less stock, so less cash tied up in stock
- reduce time between getting receivables and paying payables
-credit controllers (remind debtors to pay up with credit limits) - debt factoring
- sale and leaseback (business sell equipment to raise capital then rent equipment back).
How does financial data aid decision-making?
- helps set objectives and make plans
- assess performance
- supports investment decisions
- improves financial control
- helps manage risks
What are internal source of finance?
- Retained profit, this is when profit firm makes is retained back into the business for later investments can be used in short and long-term. Main benefit of using profit for investment is business doesn’t have to pay interest. Problems may be not all business can do this as not making enough profit, also shareholders may object this method as they wish to receive profits as dividends, retaining profits may cause firm to miss out on investment opportunities.
What are external sources of finance (short term use)?
- Overdrafts, where bank lets business have negative amount of money in its bank account, they are easy to arrange and flexible (business can borrow as little and as much as they need (up to overdraft limit)), Benefit: only may interest on amount of overdraft the use. Problem: banks charge high rates of interest on overdrafts, may also be fixed charge for using an overdraft, thus unsuitable for long-term use.
- Debt factoring, when banks/other financial institutions take unpaid invoices off hands of business, and give them instant cash payments (of less than 100% of value of invoice). Advantage is business can instantly get the money they are owed. Disadvantage is debt factoring company keeps some of money owed as a fee.
What are external sources of finance (long-term use)?
- Bank loans, external source of finance, business can borrow a fixed amount of money and pay it back over a fixed period of time with interest (amount they have to pay it back depends on interest rate and length of time the loan is for). Bank needs security for a loan, usually in the form of property. Loans are good long-term sources of finance for a start up business paying for assets (machinery, computers), not good for firms day to day running costs.
- Share capital, private and public limited companies can be financed long-term using ordinary share capital, money raised by selling shares in the business. Advantage is money doesn’t have to be repaid and new shareholders and new shareholders can additional bring expertise into firm. Disadvantages of selling shares is original owners no longer owns all business and have to pay shareholders a dividend, they may also want a say of how business is run.
- Venture capital, is funding in the form of share or loan capital is invested into a business that is thought to be high risk. Venture capitalists are professional investors who invest in business they believe have potential to be successful, they may provide business advice (ADV) but applying for funding is a long process (DISADV).
- Crowdfunding, method of financing a business or project using contributions made by large no. of people, usually done via the internet through organisations, contributors can give donations, loans, buy shares, depending on business.
