Business Finance Flashcards
Why do Businesses need Finance?
What are Short-term Finance Needs?
Finance is needed by business to meet short-term and long-term liabilities and to fund day to day activities
Short-term sources of finance are needed to meet day to day costs such as paying bills, suppliers and employee wages
They are likely to be relatively small amounts and are rarely needed beyond a year
Where revenue from sales does not cover these expenses sources such as overdrafts or trade credit may be useful
What are Long-term Finance Needs?
Longer-term sources of finance are needed to fund the purchase of non-current assets such as buildings and other types of capital resources or to acquire other businesses
These are likely to be large sums that may be required for a significant period of time
Where retained profit is not sufficient to meet these needs businesses may consider taking out long-term loans, mortgages or raising share capital
What is a Start-up Finance?
Start-up finance is needed by a new business to pay for fixed assets and current assets such as stock before it can begin trading
The amount of start-up finance a business needs is identified in the business plan
Owners often invest their own capital into a new business
Some small new business owners obtain a start-up loan to cover initial costs
What is an internal source of finance ?
An internal source of finance is money that comes from within a business
What are the main sources of internal finance ?
1- Personal savings - Money saved up by a businesses owner and invested into their own enterprise
2- Retained profit - Profit made in previous years that is available to reinvest in a business
3- Sale of Assets - Money from the sale of equipment, vehicles land, buildings or reduced-price inventory
What are advantages and disadvantages of internal sources of finance ?
Advantages - Internal finance is often free (e.g. it does not involve the payment of interest or charges)
It does not involve third parties who may want to influence business decisions
Internal finance can often be organised quickly and without significant paperwork
Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily
Disadvantages - There is a significant opportunity cost involved in the use of internal finance, e.g. once retained profit has been used, it is not available for other purposes
Internal finance may not be sufficient to meet the needs of the business
Using an internal finance method is rarely as tax-efficient as many external methods, e.g. loan repayments may be treated as a business cost and offset against tax
What is an external source of finance ?
An external source of finance is money that is introduced into the business from outside
External finance is used when a business cannot fulfil its needs with internal sources of finance
What are the main sources of external finance ?
What are overdrafts and trade credit?
An overdraft is a flexible arrangement for a business current account holder to spend more money than they have in their account
A limit is agreed and interest is charged only when a business ‘goes overdrawn
Overdraft users are typically charged interest at a daily rate
Using an overdraft for a long period can therefore be expensive compared to other methods
An overdraft may be ‘called in’ if the bank is concerned about a business’s ability to repay what it owes
Some large businesses rely heavily on overdrafts to manage working capital
Trade credit is where a business has an agreement to delay paying suppliers for a typical period of 30 to 90 days
This helps to improve the cash flow position of the business
Trade credit is usually interest-free
Large businesses tend to be able to request more generous trade credit terms from suppliers than small businesses
Businesses using trade credit may miss out on early payment discounts
What is a finance from loans ?
A sum of money is borrowed from a bank or other financial provider and repaid with a fixed interest rate over a specific period of time
The loan application must be approved before funds are transferred to the business
This may require a convincing business plan containing financial forecasts
Some financial providers demand collateral before a loan is granted
Long-term loans, known as mortgages, are used to fund the purchase of property
Repayment is typically over 25 or more years
Mortgages can have fixed or variable interest rates
What are finance from selling shares ?
A private limited company can raise finance by selling shares to friends, family or private investors such as business angels
Public limited companies can raise large amounts of finance through the initial sale of shares during stock market flotation or through a rights issue
Debentures are long-term loan certificates issued by limited companies to shareholders
Debentures must be repaid with a fixed rate of interest to lenders
What is a venture capital ?
Venture capital is sometimes available to businesses that are deemed too risky for other investors or lenders but are considered to have long-term growth potential
It generally comes from specialist businesses and banks that look to maximise their return on investment
Venture capitalists may invest technological expertise, financial advice and management experience in return for a share in the business
Their investment is usually made for a fixed period of time, typically four to six years
What is crowdfunding ?
Crowdfunding allows businesses to access finance provided by a large number of small investors on online platforms such as Kickstarter and Fundable
Investments are voluntary donations that do not have to be repaid and do not attract a dividend
The business has to reach a target amount before any funds are released
They receive no funding if the investment target is not met by a set date
Crowdfunders do not own a share of the business
They are often attracted by incentives such as a sample or early access to a product
Flow Hive is a beekeeping system that was successfully funded on Indiegogo in 2015
Its crowdfunding campaign raised $12.2 million from 38,470 backers
What are factors affecting the choice of finance ?
What are short term and long term sources of finance ?
What is the purpose of cash?
Cash is the ‘lifeblood’ of a business as without it a business will likely become insolvent relatively quickly
It is the most liquid form of current asset in the form of notes and coins on a businesses premises as well as money deposited in the bank
Compare cash and profit .
Profit and cash are different financial terminologies
Profit is calculated at a specific point in time
While a business may ultimately make a profit, they may lack cash at times because some customers may not actually have paid them yet
Profit is the difference between revenue generated and total business costs during a specific period of time
Profit can be an important indicator of a company’s financial health and long-term sustainability as it helps to assess the effectiveness of a company’s operations
What are cash inflows and outflows ?
Cash inflows are sums of money introduced to the business
Examples include money earned from sales, monies received such as loans or owners’ capital and interest from investments
Cash outflows are sums of money leaving the business
Examples include payments to suppliers, wages and salaries, loan repayments and advertising expenses
The difference between cash inflows and cash outflows during a period of time is known as the net cash flow
What is a cash flow Forecast ?
A cash flow forecast is a prediction of the anticipated cash inflows and cash outflows, usually for a six to twelve month period
A business plan should include a cash flow forecast
Business owners can identify its financial needs
Lenders such as banks can determine whether loans are capable of being repaid
What are the uses and limitations of cash flow forecasts?
Complete the cash flow forecast to show
a. Total cash outflows for March
b. Closing balance for March
c. Wages for May
d. Net cash flow for May [4 marks]
Step 1: Add all of March’s cash outflows to calculate the total
Total space Outflows space for space March space equals space 13 comma 000 space plus space 28 comma 000 space plus space 3 comma 500 space
equals space 44 comma 500 [1 mark]
Step 2: Add the opening balance to the net cash flow to calculate March’s closing balance
begin mathsize 16px style Opening space Balance space plus space Net space Cash space Flow space equals space Closing space Balance
equals space 4 comma 000 space plus space 1 comma 500 space
equals space 5 comma 500
end style [1 mark]
Step 3: Subtract inventory and miscellaneous outflows from total cash outflows to calculate wages
Wages space for space May space equals space 48 comma 000 space minus space 13 comma 000 space minus space 4 comma 000
equals space 31 comma 000 [1 mark]
Step 4: Subtract total cash outflows from total cash inflows to calculate net cash flow
Total space Cash space Inflows space minus space Total space Cash space Outflows space equals space Net space Cash space Flow
equals space 61 comma 000 space minus space 48 comma 000
equals space 13 comma 000 [1 mark]
What are some ways to solve cash flow problems ?
What is revenue ?
Revenue is the value of the units sold by a business over a period of time
E.g the revenue earned by Apple Music from sales of music downloads
What is the formula for Revenue?
Revenue = Quantity sold x Selling price
Revenue usually increases as the sales volume increases
Revenue should not be defined as ‘money earned’ as businesses can receive earnings from investments such as savings
Fotherhill Organics Limited sold 39,264 packs of its specialist compost to mail-order customers in 2022. The price per pack was £8.75. In addition, it sold 4,275 tonnes to gardening businesses for £123.95 per tonne.
Calculate Fotherhill Organics revenue for 2022 [3]
Step 1: Calculate the revenue from sales to mail-order customers
39,264 x £8.75 = £343,560 [1 mark]
Step 2: Calculate the revenue from sales to gardening businesses
4,280 x £123.95 = £530,506 [1 mark]
Step 3: Add the two revenue figures together
£343,560 + £530,506 = £874,066 [1 mark]
What is fixed variable & total costs ?
n preparing goods/services for sale, businesses incur a range of costs
Some examples of these these costs include purchasing raw materials, paying staff salaries and wages, and paying utility bills such as electricity
These costs can be broken into different categories
Fixed costs (FC) are costs that do not change as the level of output changes
These have to be paid whether the output is zero or 5000
E.g. building rent, management salaries, insurance, bank loan repayments etc.
Variable costs (VC) are costs that vary directly with the output
These increase as output increases & vice versa
E.g. raw material costs, wages of workers directly involved in the production
Total costs (TC) are the sum of the fixed + variable costs
What is profit & loss?
Profit is a surplus that remains after business costs have been subtracted
If costs exceed revenue the business makes a loss
Most businesses have the main objective of making a profit
Profits help new businesses to survive and break-even
It is a reward for risks taken by entrepreneurs and investors
Established businesses can use profit to fund long-term growth
What is the most simple formula for calculating profit?
Profit = Revenue - total cost
How is profit made ?
In 2022 Fotherhill Organics Limited achieved revenue of £874,066 from sales of its specialist compost. In addition, it incurred total costs of £578,033
Calculate Fotherhill Organics profit for 2022 [1]
Step 1: Subtract total costs from revenue
= £ 874,066 - £ 578,033 = £296,033
What is the break even point ?
The break even point is the number of units a business must sell to reach the point where revenue is equal to total costs
At the break even point neither a loss nor a profit is made
It helps businesses understand the minimum level of sales or output they need to achieve in order to cover all costs
This helps business managers to make informed decisions about pricing and production volumes
Calculation of the break even point requires three elements
What are the 3 elements of the break even analysis ?
What are fixed costs ?
Fixed costs are costs that do not change regardless of the level of production or sales
E.g. rent, salaries and insurance
What are variable costs?
Variable costs are costs that vary with the level of production or sales
E.g. raw materials, direct labour costs, packaging and shipping costs
How do you calculate the break-even point ?
What is the gross profit margin ?
Head to Toe Wellbeing’s revenue in 2022 was $124,653. Its gross profit was $105,731
Calculate Head to Toe Wellbeing Ltd’s Gross Profit Margin in 2022 [2 marks]
How are some ways to increase the gross profit margin ?
What is the operating profit margin ?
How do you increase the gross profit margin ?
How do you increase gross profit margin ?
What is the operating margin formula ?
Head to Toe Wellbeing’s revenue in 2022 was $124,653. Its gross profit was $105,731
Calculate Head to Toe Wellbeing Ltd’s Gross Profit Margin in 2022 [2 marks]
What is the mark-up formula?
Evolve Boards’ bestselling penny skateboard costs $12.13 to produce. Each board is sold for $20.
Calculate the percentage markup on each penny skateboard sold [2 marks]
What is the return on capital employed formula ?
What is the capital employed formula ?
The table shows an extract from the company accounts of Keals Cosmetics.
Non-current Liabilities €1.5 million
Revenue €7 million
Equity €15.4 million
Operating Profit €2.2 million
Calculate Keals Cosmetics’ Return on Capital Employed.
[3 marks]
Faced with increasing costs, Kent & Medway Properties Ltd is looking to close one of its three high street real estate branches.
The table below shows some key data for each of the branches.
Branch Capital Employed Operating Profit
Sevenoaks £2.4m £0.37m
Whitstable £3.1m £0.57m
Rochester £2.9m £0.51m
Calculate the Return on Capital Employed (RoCE) for each branch and recommend which branch, on profitability terms, should close
What is the current ratio ?
The Current Ratio is a quick way to measure liquidity
The outcome is expressed as a ratio
All types of current asset are included in calculating this ratio
The result indicates how many £s (or other currency units) of current assets are available to cover each £1 (or other currency unit) of short-term debt
Packer Sports Ltd has current assets of $15,545, current liabilities of $5,060 and an inventory figure of $8,250.
Calculate Packer Sports Ltd.’s current ratio. [2]
What is the Acid test ratio ?
The acid test ratio is a precise and realistic way to measure liquidity, especially for businesses that hold large amounts of inventory
It is expressed as a ratio
It is also known as the liquid capital ratio
The least liquid form of current assets (inventory) is deducted so the acid test ratio provides a more realistic measure of the businesses ability to meet short-term debts quickly
It often takes time to sell inventory so it is excluded
Packer Sports Ltd has current assets of $15,545, current liabilities of $5,060 and an inventory figure of $8,250.
Calculate Packer Sports Ltd’s acid test ratio. [3]
How do you improve liquidity ?
How do stakeholders use financial documents ?
What decisions can be used using financial statements ?
