Chapter 6 Flashcards
What are the 5 reasons firms need finance?
1) start up capital
2) new firms have poor initial cashflow, will need to cover costs
3) if there are payment delays,lack of liquid cash
4) if a business is struggling to meet day to day running costs
5) may want to expand
What are government grants?
- usually for smaller firms
- dont have to be repaid
- strict criteria on how the money is spent
What is a source of finance for small firms?
Government grants
Sources of finance for the short term?
- trade credit
- overdrafts
What is a trade credit?
- businesses may give firms one or two months to pay for certain purchases
- useful for small firms as they have time to earn money
- however could end up with large payment if they leave it too later.
What are overdrafts?
Firms take money out of bank account than it has paid into. Overdrafts allow businesses to make payements on time. Usually very high interest rates and the bank can cancel them at any time. If it isn’t paid of the bank can seize the businesses assets.
What are long term sources of finance?
- loans
- hire purchases
What type of loans can you get?
- bank loan
- friends or family loan
- mortgages
What is collateral ?
In a mortgage the property is used as collaterall - this means that the property can be taken by the bank if the individual cant pay off the mortgage.
What are mortgages?
- Lower interest payments
- for property
- collateral is used if failed to pay back
What are bank loans?
- Quick and easy to take out
- repaid with interest
- bank can reposses firms assets
What are hire purchases ?
- when firms purchase something by leaving a deposit
- then paying rest in instalments over a period of time
- allows firms to purchase useful things that their business wouldn’t of been able to
Sources of finance for established firms?
- retained profits
- selling fixed assets
- new share issues
What is internal finance?
Finance from inside the business. Easiest way to get money , and dont have to pay interest
What is external finance?
Comes from outside the business. It usually needs to be paid back , sometimes with high interest
Examples of internal sources of finance?
- personal or business savings
- retained profits
- selling fixed assets
Examples of external sources of finance?
- banks loans, overdrafts and mortgages
- loans from family and friends
- new share issues
- trade credit
- government grants
- hire purchases
What four factors that effect the choice of finance?
- size and type of the company
- amount of money needed
- length of time
- Cost of the finance
What is an investment?
Is money which is put into a business to make improvements in order to make the business more profitable
Examples of business investments?
- new machinery
- new buildings
- new employees
- new vehicles
What is the average rate of return?
Calculation of the average return on an investment over its lifespan
Equation for average rate of return?
Average annual profit / initial investment X 100
What is revenue?
Amount of money business earns
What are costs?
Amount of money a business has to spend
What is profit?
This is the money left over after costs are taken away
What is loss?
When costs are greater than revenue the business makes a loss-they lose money.
What are fixed costs?
Costs that dont change with output
What are variable costs?
Costs that will increase as output increases
What are total costs?
Fixed + variable costs
What is the break even output?
Level of output where the firm will just cover its costs. It it sells more it will make a profit , if it sells less, it’ll make a loss.
How to make a break even chart?
Worked out by making a break even chart- this has output on the x axis and costs and revenue on the y axis
Where does a firm break even?
When the lines for total revenue and total costs cross
What is the margin of safety?
Gap between the current level of output and the break even output
Advantages of break even analysis?
- its easy to work out
- its quick. This means that if business decide to they want to increase their margin of safety , they can take immediate action to increase sales or reduce costs
- allows businesses to predict how changes in sales can effect the business
- businesses can use break even analysis to help persuade a bank to give them a loan
- it can stop businesses from releasing products that might be difficult to sell in large quantities
Disadvantages of break even analysis ?
- it assumes firm can sell any quantity of the product at the current price
- break even analysis assumes that all the products are sold , without waste
- if date is wrong , results of analysis will be wrong
- it can be complicated if it involves more than one product
- it only shows how much a business needs to sell, and how much it actually will sell.
What is cash?
Money a company can spend immediately , it is liquid
What is cash flow?
Flow of money into and out of the business.
What is net cashflow?
Difference between cash inflow and cash out flow over a period of time
What is positive cashflow?
When a company has more cash inflow than outflow
Why a cashflow forecast is important?
Good way of predicting when a firm might face a liquidity problem(lack of cash). May need to get a loan or overdraft
What is a cashflow forecast?
Lists all the inflows and outflows of cash that appear in the budget.
Equation for the closing balance?
Opening balance + net cash flow
What are credit terms?
Tell you how long after agreeing to buy a product the customer has to pay . This can effect the timings of their cashflows.
What does poor cashflow mean?
Not enough cash to meet day to day expenses
What can poor cashflow lead too?
- staff may not get paid on time , poor motivation
- creditors (people firms owe money ) may not get paid on time, this can lead to asset seizures or legal action
Three main reasons for poor cashflow?
- poor sales
- overtrading , firm takes too many orders so buys too much raw materials , this will increase costs and if not efficient in trading will loose money and wont be able to pay back debts
- poor business decisions
How to improve cashflow?
- reschedule payments
- reducing cash outflow
- arrange to have overdraft
- find new sources of finance
- increase cash inflow
What are the three parts of an income statement?
- trading account
- profit and loss account
- appropriation account
What is the trading account section?
Records the firms gross profit or loss
How to find gross profit?
Revenue - direct costs
What does a profit and loss account record?
All the indirect costs of running a business
What is the operating profit?
After all the indirect costs are taken away from the gross profit
What is the net profit?
Any interest paid or received is included, take it away from operating profit . What is left is the net profit
What is the appropriation account ?
Last part of the statement is only included for limited company accounts. It records where the profit has gone - to the government as tax, to shareholders as dividends , or kept in the businese as retained profits
How gross profit effects a business?
Business needs to decrease average unit cost, or increasing revenue
How operating profit effects business performance?
Decrease businesses indirects costs
How retained profits effect a business?
Tells you if a company is profitable or not. Shareholders and potential investors will look at this figure to assess investments. Also shows how much internal finance the firm can invest
What is the gross profit?
Fraction of every pound spent by customers that doesn’t go directly towards making a product
How to work out gross profit margin?
Gross profit /sales(revenue) X 100
What is the net profit?
Fraction of every pound spent by customers that the company gets to keep
How to work out the net profit margin ?
Net profit / sales (revenue ) X 100
Examples of fixed assets?
- premises
- machinery
- vehicles
What is a balance sheet?
Records where the business got its money from, and what it has done with it
How are current assets ordered on a balance sheet?
Order of liquidity
What are current liabilities?
Payments the firm will have to make within one year of the date on the balance sheet
What are debtors on a balance sheet?
Refers to the value of the products sold- usually on credit - that have not yet been paid for by customers . Whats happening here is that the firm is lending money to customers so they can buy its products
What is the most liquid asset?
Cash
What are creditors on a balance sheet?
Opposite of a debtor - it is money the firm owes to its suppliers.
Why are current liabilities listed?
Money isn’t really belong to the firm , since it has to be repaid to somebody else pretty soon , so this is taken away from the current assets figures
How to work out net current assets ?
Current assets - current liabilities
What is the net current assets?
Money available for day to day operating of the business . Its also called working capital
How to get the net worth / net assets?
Net current assets + fixed assets
What are shareholder funds?
Share capital and retained profit and reserves
What is share capital?
This is the money put into the business when shares were originally issued. This might have been years and years ago for long established companies
What is retained profit and reserves?
This shows all the profit that the firm has made over the years that it has made over the years that it has decided to keep instead of paying dividends.
What are long term liabilities ?
Money borrowed , that will take over a year to pay back
What is capital employed?
What you get when you add shareholders funds to long term liabilities. This is equal to net assets because it is where the money is from.
