Finance Flashcards
Start up capital
The capital needed by an entrepreneur when first starting a business
Working capital
The capital needed to finance the day to day running expenses and pay short-term debts of a business
Non currrent assets
Resources owned by a business which will be used for a period longer than one year (e.g buildings and machinery)
Capital expenditure
Spending by a business on non-current assets such as machinery
Why do businesses need finance?
- To pay day to day expenses of the business (e.g wages, materials etc.)
- Purchasing non current assets (e.g machines)
- Investing in technology
- To finance expansion
- To conduct market research
Long term finance
Debt or equity used to finance the purchase of non-current assets of finance expansion plans.
Short term finance
Loans or debt that a business expects to pay back within a year
Internal sources of finance
Capital which can be raised from within the business itself
- Owners savings
- Retained profits
- Sale of non current assets
- Use of some of the business’s working capital
Retained profit
Profit remaining after expenses, tax and dividends have been paid, which is put back into the business
External sources of finance
This is capital which is raised from outside the business. External sources of finance are usually divided into short term and long term sources
Short term finance
- Overdraft
- Trade credit
- Debt factoring
Long term finance
- Loan
- Leasing
- Mortgage
- Debenture
Overdraft
An agreement with the bank which allows a business to spend more money than it has in its account up to an agreed limit. The loan has to be repaid within 12 months
Trade credit
Where suppliers deliver goods now are are willing to wait for a number of days before payment
Factoring
When firms sell their invoices to a factor such as a bank. They do this for cash rather than waiting 28 days to be paid the full amount
Debentures
Loans made to a company
Mortgage
A special type of loan for buying property where monthly payments are spread over a number of years
Cash flow forecast
An estimate of the future cash inflows and outflows of a business
Net cash flow
Cash inflow minus cash outflow
Interpreting cash flow statements
The most important line on any cash -flow statement is the one containing the closing balance. If a businesses cash flow position is forecast to become negative, they might chose to finance it with an overdraft.
How to finance a short-term cash shortage
- Ask trade receivables to pay more for goods more quickly by offering discounts to customers who have good credit
- negotiate longer term credit terms with suppliers
- Delay the purchase of non-current assets
- Find other sources of finance for the purchase of non-current assets
Gross profit
The difference between revenue and cost of sales
Profit
The difference between revenue and costs
Total costs
Cost of sales + expenses
Revenue
The amount earned from the sale of products
Cost of sales
The cost of purchasing the goods used to make the products sold
Expenses
Day to day operating expenses of a business
The importance of profit to private sector businesses
- Measure the success of a business
- Measure the performance of managers
- Decide whether or not to continue making or selling a product
- Finance the purchase of non-current assets
Income statements
Financial statement which records the revenue, costs and profits of a business for a given period of time
Use of income statement
Internal and external stakeholders can use the information when analysing business performance. The most important figure is profit.
Balance sheet
An accounting statement that records the assets liabilities and equity of a business at a particular date
Assets
Resources that are owned by a business
Liabilities
Debts that will have to be paid sometime in the future
Current assets
Resources that the business owns and expects to convert to cash before the date of the next balance sheet
Trade receivable
The mount of money owed to the business by customers who have been sold goods on credit
Trade payable
The amount a business owes to its suppliers for goods bought on credit
Non-current liabilities
Debts which will be payable after more than a year
Owners equity
The amount owed by the business to its owners (including capital and retained profits)
How to interpret financial statements
- Identify its strengths and weaknesses so that it can be decided which, if any, of its policies or strategies née to be changed
- Show heather the business is meeting its objectives
- Improve future business performance
Gross profit margin
Ratio between gross profit and revenue
(gross profit/revenue)x100
Profit margin
Ratio between profit before tax and revenue
(profit/revenue)x100
How to improve ratios
Increase denominator
Decrease numerator
Liquidity
The ability of a business to pay its short term debts
Current ratio
Ratio between current assets and current liabilities
current assets/current liabilities
Acid test ratio
Ratio between liquid assets and current liabilities
(current assets - inventories)/current liabilities
Interpreting acid test ratio
A ratio of 1:1 is satisfactory. If it is lower than this there is a risk of the business not having enough cash to pay its short-term liabilities. If it is too high, then cash is being tied up in unprofitable assets.
