Household and Business Management: Cash Flow Forecasts and Business Finance Flashcards
Cash Flow Forecasts for Households
Households generally budgets to predict future incomes and future expenditures in order to have enough cash to cover costs. This budget includes the money the household expects to make (income) and payments (expenditure). There are three types of expenditure- Fixed, Irregular, Discretionary.
Cash Flow Forecasts for Businesses
Businesses use cash flow forecasts to predict how much money a business will have in the future. It does this by subtracting expected future payments from expected future income. Money coming in is called receipts, and money going out is called payments.
Why does a household/business need cash flow management?
Financial control mechanism
Avoid cash flow problems
It lets us know in advance when there will be a deficit, It lets us know in advance when there will be a surplus
Identifies times when high expenditure may be needed
It can set a target
The cash flow forecast can be used as a tool in applying for a loan.
Avail of a short-term source of finance
Company X could arrange a bank overdraft facility with its bank to finance problem months where the business is running a deficit. The overdraft facility provides extra flexibility for Company X when it needs it most.
Adjust receipts
Its receipts could be increased by changing its marketing mix, e.g. lowering price to sell more, increasing the price depending on elasticities, designing new products or more effective promotion campaigns/reducing period of credit given to debtors/cash sales only.
Adjust payments
The business could decrease its cash payments by sourcing cheaper suppliers, restructuring loan repayments or asking employees to take a wage decrease etc…
Sell of an asset
• Look to sell of an asset to raise capital. Company X could look to sell an asset such as a machine that is now obsolete to get an instant cash injection into the business
Short Term Finance
Bank Overdraft Credit Card Accrued Expenses Factoring Trade Credit
Medium Term Finance
Medium Term Loan
Hire Purchase
Leasing
Long Term Finance
Mortgage Savings Retained Earnings Equity Capital Grants Debentures Sale and Leaseback Venture Capital
Bank Overdraft (Business and Household)
- This is a short-term loan given to a current account holder for a period of less than one year. The current account holder gets permission from the bank to withdraw more money from their account than they have in it (up to a certain limit).
- Interest is charged on the amount outstanding every quarter (i.e. every three months) and this interest is calculated on a daily basis.
Credit Cards (Business and Household)
- A customer will pay for goods and services using credit cards at the point of sale
- The credit card company pays the supplier, and the customer will pay the credit card company at the end of the agreed period with interest charged if the full balance is not paid
Accrued Expenses (Household and Business)
• Accruals are services which we have the use of now but which we pay for later, eg. telephone, electricity, or gas bills. It is essentially the delaying of the payment of bills to free up money to spend on other items.
Factoring (Business Only)
- A Debtor is someone who we sell goods or services to now, but who we receive payment from later.
- Debtors pay us at different times, some in two weeks, some in a month, some in two months; this makes it difficult to plan expenditure.
- Firms can thus sell their debtors to a factoring firm and factors charge for the service
Trade Credit (Business Only)
- Purchasing goods now and paying for them later is called buying on credit
- Selling goods now and receiving payment for them later is called selling on credit
- Trade Credit gives a company time to manufacture, sell and get paid for their products before they have to pay their creditors
Medium Term Loan (Business and Household)
- Here, a borrower takes out a loan from a financial institution and repays it with interest over an agreed period of time
- The interest repayments can be fixed or variable and it is important for the household or business to shop around for the best rate
- Loans given to households are called personal loans
- Loans given to businesses are called medium term loans
Hire Purchase (Business and Household)
- This is a form of credit which allows customers to have immediate use of goods while paying for them over an agreed period of time in instalments. The customer pays an initial deposit and then instalments. The customer only owns the asset when the last instalment has been paid
- It is used to buy assets such as motor vehicles, equipment, etc…
- It carries a high rate of interest and is thus an expensive form of finance
- There are strict conditions attached to Hire Purchase which are set down in a written contract for the customer
Leasing (Business and Household)
- Leasing is like renting. The asset acquired is at all times owned by the lessor who rents it to the lessee over an agreed period of time in return for regular payments. Ownership thus never passes to the person renting it (the lessee). Leasing is cheaper than hire purchase as no change of ownership is involved
- A lease agreement involves the payment of a deposit and a number of fixed deposits being paid (the number of which is agreed in advance. At the end of the agreement the asset is returned to the seller
Mortgage (Household)
- A Mortgage is a loan to buy a house or property that can be repaid over a period of 20 – 35 years. The borrower repays the loan and interest by the end of this time. This type of finance doesn’t relate to the businesses
- The mortgage is secured on the house or property (a farm). If the borrower fails to repay the loan, the title deeds of the house or property are given to the lender. The House/property can be sold and the proceeds used by the lender to pay off the loan.
Savings (Household)
• Savings is money the household has not spent but saved for the future. A household will usually put their savings in a financial institution to earn interest, with the savings used to purchase assets like an extension to the house
Retained Earnings (Business)
- These can be known as reserves and mean that profits are ploughed back into the business to assist its growth
- When a business makes profit, these profits don’t have to be paid to the directors or paid to the shareholders; they can be put on deposit or invested. These profits build up over a period of time, and are effectively the same as savings for a household.
Equity Capital (Business Only)
- Equity is funds that have been invested in the business by shareholders with the hope of a future dividend
- Business owners sell shares to investors to raise more capital, and the investors have a say in the running of the business
Grants (Business Only)
- Government grants are non-repayable amounts of money given to enterprises by state agencies which aid certain activities such as purchasing factories and machinery or train workers that help develop the business
- With increasing Government cutbacks, conditions are imposed when issuing grants. These can come in the form of performance targets. E.g. a certain amount of money can be given to a company provided a specified number of people are employed. Failure to meet these targets can result in the demands for the grant to be repaid.
Debentures (Business Only)
• This is long term finance similar to a loan. A firm will use their assets to borrow a large sum and pay interest only on that sum for a period of time. At the end of that time, they then pay the full amount back in one lump sum
Sale and Leaseback (Business Only)
- This is when a business sells an asset and then leases it back from the buyer
- This will allow the business to still use the asset while at the same time getting extra finance
Venture Capital (Business Only)
- This is provided as start-up (seed) capital for new business enterprises and as development capital for existing businesses in which there is a higher than average degree of risk. The risk will be high but the possible returns on profit will also be high
- The venture capital company will usually want to place members of its own staff on the board of directors to oversee the new firm’s progress. This is known as a partnership approach and raises the image of the business with customers, suppliers and banks
- Once the business becomes successful, the venture capital company sells its shares for a profit
How Should the Source of Finance be selected?
Amount Purpose Cost Collateral Timing of Repayments Conveniance Control
Purpose of the loan
If it is productive and low risk, the bank will look more favourably on the loan.
Ability to repay
Examine the income- p60 for house/profits for business.
Security for the loan
Look at collateral- e.g. title deeds of property, share certificates in company.
Banking record
A good banking history will be looked upon favourably.
Credit rating
The bank may check a borrower’s credit rating with a reputable agency that specialises in this area. If the rating is good, the bank will advance the loan.
Business plan
Case of a business- growth potential will be looked upon favourably
Own investment
A bank which is asked to loan money will be more assured if the person is investing a significant amount themselves.
