6 - Finance Flashcards
Why does a new Business need to raise finance (5)
- Renting or buying a building
- Vehicles - businesses may require cars to visit customers and suppliers as well as vans or lorries to deliver products
- Advertising the business - potential customers wont know about a new business unless it promotes itself
- Equipment and machinery for the business
- Inventories of raw materials - e.g a greengrocer will need to buy inventories of fruit and vegetables to sell
Entrepreneur
Is someone who is willing to take risks involved in starting a business
Inventories
Are raw materials that have not yet been used or products that have been, but not sold, these are also called stocks
Why would an established business need to raise finance to expand (3)
- To pay for additional shops,factories or offices as well as recruit new employees
- e.g Spotify attempted to raise $500 million to fund further global expansion
Why would an established business need to raise finance to improve efficiency (2)
- To train employees - could lead to an increase in output with fewer resources used
- Purchase new technology used in production
Why would an established business need to raise finance to develop new products (2)
- Developing new products is an important way for firms to compete
- A business may need to pay for research and advertising e.g Nissan spent £100 million at its factory in Sunderland to enable it to make it new Juke car there
Internal sources of finance (4)
- Owners’ funds
- Sale of unwanted assets
- Trade credit
- Retained profits
External sources of finance (6)
- Bank loans and mortgages
- Hire purchase
- Share issues
- Family and friends
- Overdrafts
- Government grants
Advantage of Owners’ funds
The business does not have to pay any interest
Disadvantage of Owners’ funds
The owner of a new business may have to use their savings to invest in the business
Advantage of retained profits
- Can be available immediately to a successful business
* No interest as the money is being borrowed
Disadvantages of Retained profits (2)
- Only available to successful firms that have made a profit
* Shareholders disappointed if profit is kept within the business and not being paid to them as dividends
Advantages of selling assets
- Can provide a business with large sums of money
* No interest charges
Disadvantages of selling assets (2)
- A business may sell an asset which it will need later on
- If a business sells an asset and leases it back, the business will have to pay a sum of money regularly - may reduce a business’s long term profits
Trade Credit
is a period of time which suppliers allow customers before payment for supplies must be made
Advantage of trade credit
• No interest charge
Disadvantage of trade credit (2)
- Very short term
* Only relatively small sums of money can be raised in this way
Advantages of bank loans and mortgages
- Can be arranged quickly
* Allows repayment over a long period of time
Disadvantages of Bank loans and mortgages
- Interest has to be paid
* Banks may require an asset as collateral (an asset that a bank holds as security)
Advantage of selling shares
No interest payments
Disadvantages of selling shares
- The owner may lose control of the company
* Only available to companies
Advantage of Governments grants
• Many government grants do not have to be repaid
Disadvantages of Governments grants
- A business may have to meet struct conditions to receive a grant
- Businesses may have to invest money alongside the grant
Factors which influence the choice of sources of finance for an existing business (5)
- Past history and future prospects
- The business profitability
- Assets owned by the business
- The amount of finance needed
- The legal structure of the business
Factors which influence the choice of sources of finance for a new business
- The amount of personal finance
- How risky the business is judged to be
- The amount of finance needed
- The legal structure of the business
How does the amount of personal finance influence the choice of a source of finance (3)
- The more personal finance an entrepreneur has, the less he or she needs to raise from other sources
- They may receive compensation (redundancy pay) which can be used to start up
- Entrepreneurs may sell their homes to raise funds
How does the legal structure influence the choice of a source of finance (2)
- A new business may be an Ltd - raising funds by selling shares is possible
- However, an Ltd may only be able to make a limited use of shares as all shareholders have to agree for this source to be used
How does risk of a new business influence the choice of a source of finance (2)
- Sources of finances available will be reduced if the business is seen to be risky
- In these circumstances, an entrepreneur may be forced to rely on their own finance or form a company and sell shares within it
How does profitability influence the source of finance for an established business (2)
- If a business is profitable they will be able to use retained profits
- If a business is profitable they will be more likely to persuade a bank for a loan
How do assets influence the source of finance for an established business
- They can sell them and lease them back if necessary
* If assets are valuable they can get bank loans due to suitable collateral
How does past history and future prospects influence the source of finance for an established business
• If a business is expected to make a profit it puts them in a strong position to get a loan
Cash flow
Is the flow of all money into and out of the business
Why might a business receive cash inflows (3)
- Income from sales
- Loans from banks
- Money invested by the business’ owner
Cash outflows (5)
- Buying raw materials
- Wages
- Rent or mortgage
- Interest on loans
- Taxes
Benefits of having a positive cash flow (3)
- The business does not need to borrow therefore avoiding interest charges
- The business will be able to arrange more long term loans with banks - as banks will have confidence the business will pay back in time
- Reduces the risk of a business failing
What is a cash flow forecast
Is a plan of the expected inflows and outflows to and from a business over a period of time
How are cash flow forecasts constructed (4)
Normally organised into 3 sections:
• Cash inflows at the top
• Second section is Cash outflows
• Third section includes Net cash flow, opening balance and closing balance
What is the importance of cash flow forecasts
- Managers can identify times when the business will be short of cash
- Managers can take suitable actions to avoid cash shortages becoming a major problem
How is rescheduling payments a suitable solution for cash flow problems (2)
- The business may be able to agree with suppliers to be able to delay their payments - this can give the business sufficient time to receive inflows of cash
- Or, the business may be able to persuade customers to pay more quickly - speeds up cash inflows
How is cutting costs a suitable solution for cash flow problems (2)
- If a business can reduces its costs (perhaps by employing fewer staff or holding smaller stocks of raw materials) - should lead to reduced cash outflows
- The business could use cheaper sources of fuel and raw materials - however could lead to a reduction in quality and in the long term loss of customers
How is using overdrafts a suitable solution for cash flow problems (2)
- Short term and flexible - Can provide the business with the cash it needs as it provides an immediate inflow of cash
- However, is a relatively expensive form of borrowing - if a business uses them extensively it may damage profits
How is finding new sources of inflow a suitable solution for cash flow problems (2)
- Many public houses offer accommodation and meals especially in places with tourists - this can generate significant inflows
- However, it can take time to implement and may involve further cash outflows
Profit
Measures the difference between the values of a business’s revenue (sales) and its total costs
Why is cash flow important (3)
- If a business doesn’t have enough it won’t be able to play its expenses
- If a business does not have cash it wont be able to pay for supplies - suppliers may stops supplying
- If a does not have cash it business wont be able to pay staff - forcing a business to stop
Variable costs
Are the costs that vary directly with the business’s level of output
Fixed costs
Are the costs that do not change when a business changes its output
Total costs
Are fixed costs + variable costs
Revenue (3)
- Is the income that a firm receives from selling its goods or services
- It is also referred to as ‘turnover’
- measured by the number of units sold x the price
Costs
Are the spending that is necessary to set up and run a business
Profit
Measures the difference between the values of a business’s revenue (sales) and its total costs
Loss
Is the amount by which a business’s costs are larger than it’s revenue from all sales
What are the main investment projects business’ undertake (3)
- Land and buildings - to be able to supply goods and services or expand
- Machinery and vehicles - advances in technology lead to kore productive machinery being available can help business’s to compete and more profitable
- New products - can help to compete
How to calculate Average rate of return (ARR) (2)
Step 1:
Total profits divided by number of years = average yearly profit
Step 2:
Average yearly profit x 100 divided by cost of investment project = Average rate of return (ARR)
Break-even
Is the level of production at which a business’s total costs and revenue from sales are equal
Margin of safety
Measures the amount by which a business’s current level of production exceeds its break-even level of output
Advantages of using break-even analysis (3)
- Help managers to see the effects of any changes in costs - helping mangers to prepare for future changes in costs
- Shows the effects of changes in price - e.g managers can use break-even charts to analyse whether a fall in price might lead to the business making a loss rather than a profit
- Banks more likely to agree a loan if a business is able to provide evidence of planning future finances
Disadvantages of using break-even analysis (2)
- It assumes that a business sells all of the output it produces which is unlikely (even for a well known business)
- Businesses may operate in markets where costs and prices change rapidly and frequently - making break-even charts of less value as they are inaccurate due to large and frequent changes
Why are financial statements important (3)
- It is a legal requirement - if failed to be prepared a business can be fined or in extreme cases forced to cease trading
- Helps the business’s managers make decisions on how to improve the business’s performance
- Guide investors - helps them to judge whether the investment will earn a profit
Main components of an income statement (6)
- Revenue
- Cost of sales
- Gross profit
- Overheads
- Operating profits
- Net profit
Main components of a balance sheet (4)
• Assets • Liabilities • Total equity • balancing assets and equity Therefore provides a snapshot of the business's financial position
Assets
Is anything that is owned by a business
Liability
Is a sum of money that is owned by a business to another business or an individual
How to interpret financial statements (3)
- Compare with previous years
- Compare with performance of competitors
- Judging financial performance from the perspective of different stakeholders
How does comparing with previous years help consider current performance
Key indicators are:
• The revenue from sales of goods and services
• gross and net profits
How does comparing with performance of competitors help consider current performance
Compare the two income statements - if a business csn increase its revenue and profits more quickly than others in the same industry its a good sign in financial terms
How does judging financial performance from the perspectives of different stakeholders help consider current performance
Shareholder and owners:
• level of sales achieved
• costs the business has paid
• Amount of profit or loss that has been made
Managers - to decide whether decisions are effective
Suppliers - whether or not a business has made a profit guides them to if they will be paid in future
Employees - pay may depend on profits the business makes
How to calculate gross profit margin and how it helps to asses financial performance
- Gross profit divided by revenue x 100 = gross profit margin
- Not great as it doesn’t include all the costs paid by the business - it only includes a business’s cost if sales
How to calculate net profit margin and how it helps to asses financial performance
- Net profit divided by revenue x 100 = net profit margin
* good indicator as its calculation includes all the costs paid by the business
