Finance Flashcards
Why do businesses need finance
• It is needed to meet short term and long term needs
• to set up and grow a business
Short term needs for finance
• day to day costs
• pay workers
• pay suppliers
long term needs for finance
• purchase property
• upgrade machinery
needs for finance : start up
• buy initial stock
• advertising
• equip stores / offices
needs for finance : growth
• extend property
• increase distribution
• expand workforce
Sources of internal finance
• personal savings
• retained profit
• sale of assets
define personal savings
money saved up by a business owner and invested into their own enterprise
define retained profit
profit made in previous years that is available to reinvest into a business
define sale of assets
money from selling equipment, vehicles, land, buildings, or reduced price inventory
Advantages of internal sources of finance
• cheap
• quick
• complete control
• no external influence
• less risk
Disadvantages of internal sources of finance
• limits funds
• slower growth
• loses potential for other opportunities
External sources of finance
• overdraft
• venture capital
• crowdfunding
• share capital
• loans
• trade credit
define overdrafts
a flexible arrangement with a bank to allow a business to spend more than it has in its account
define trade credit
An agreement with a supplier to receive goods now and pay at a later date
define loans
a sum of money borrowed and repaid (with interest) over a period of time
define share capital
money raised from the sale of shares
define venture capital
money received from investors (that specialize in high-risk enterprises) in return for a share of the business
define crowdfunding
• raising modest investments from many people to fund a business project
• usually using an online platform
short term sources of finance
• overdraft
• trade credit
long term sources of finance
• share capital
• bank loans
• retained profits
• crowdfunding
The importance of cash to a business
• to pay suppliers, overheads, and employees
• to prevent business failure
Difference between cash and profit
CASH
• the actual money a business has at any moment
• includes physical cash, money in bank and liquid assets
PROFIT
•The financial gain a business makes from its activities
• calculated as the difference between revenue and expenses
Define cash inflows
sums of money introduced to the business
How to calculate net cash flow
Cash inflows - cash out flows
define cash outflows
sums of money leaving the business
Define net cash flow
the difference between cash inflows and cash outflows during a period of time
What is a cash flow forecast
a prediction of the anticipated cash inflows and cash outflows usually for a 6 to 12 month period
Uses of cash flow forecasts
• support an application for a loan
• important part of decision-making
• help identify where the business may experience cash shortfalls or cash surpluses
limitations of cash flow forecasts
• based on estimates, so may not always be accurate
• require appropriate skills, insights, research and time to prepare and update
• external factors that can impact inflows and outflows may not be reflected into the forecast
define opening and closing balance
opening balance = previous months’ closing balances carried forward
closing balance = adding net cash flow to opening balance
define revenue + formula
• value of units sold by a business over a period of time
• revenue = quantity sold × selling price
define fixed costs
costs that do not change as the level of output changes
define variable costs
costs that vary directly with the output
define total costs
fixed costs + variable costs
formula for profit
profit = revenue - total costs
Define break even point
• The number of units that the business must sell so revenue is equal to total costs
• at break even point, neither a loss or a profit is made
formula for break even
fixed costs / (selling price - variable cost)
limitations of break even charts
• some output may remain unsold
• cost data is usually an estimate
• revenue does not always increase in direct proportion to units sold
• costs does not always increase in direct proportion to units sold
Define statement of comprehensive income
• financial focument that shows a firms income and expenditure over a period of time (usually 1 year)
• also known as profit and loss statement
formula for gross profit
revenue - costs of sales
formula for operating profit
gross profit - expenses
Questions to ask when interpreting (statement of comprehensive income) if business is making a profit
• Is the profit higher or lower than last year ?
• is the profit higher or lower than competitors
Questions to ask when interpreting (statement of comprehensive income) if business is making a loss
• is this a short-term or long-term problem?
• are competitors making losses?
Define statement of financial position
• shows the financial health of a business at a specific point in time
• also known as balance sheet
define assets
items owned by a business
define current assets
Cash and other properties owned by a business that can be converted into cash in one year
define non-current assets
assets that the company owns and needs more than one year to convert into cash
define current liabilities
• has to be repaid in 12 months
e.g. overdraft, tax
define non-current liabilities
• long term debts
e.g. mortgage, long term loans
Define capital employed
•how the business is funded
•also known as equity
What are profit margins
• they measure how effectively a business converts revenue into profit
• can be compared to previous years to understand business performance
formula for gross profit margin
( gross profit / revenue ) × 100
how to increase gross profit margin
• increases revenue
• reduce direct costs
formula for operating profit margin
( operating profit / revenue ) × 100
How to improve operating profit margin
• reduce expenses
• increase profit margin
define mark-up
a measure of profit made on each item sold
formula for markup
(profit per item / cost per item) × 100
Return on capital employed (RoCE)
measures how effectively a business uses the capital invested in the business to generate profit
formula for RoCE
(operating profit / capital employed) ×100
How to improve RoCE
(higher rate the better)
• increase level of profit without new capital
• maintain level of profit whilst reducing the amount of capital
Define liquidity
how easily assets can be converted into cash
Liquidity ratios
• current ratios
• acid test ratio
formula for current ratio
current assets / current liabilities
formula for acid test ratio
(current assets - inventory) / current liabilities
Ways to improve liquidity
• manage the business better
• reduce credit period offered to customers
• ask suppliers for extended repayment period
• use overdraft or short term loans
• sell excess inventory
• sell assets
• introduce new capital and reduce drawing out of the business
How are financial documents used
stakeholders use them to assess business performance and inform decision making
Decisions using financial documents
• managing assets
• improving profit
• investment
• financing
