Management of Finance Flashcards
What is personal finance
Personal savings and money borrowed from family and friends
What is retained profits
A business holding back profits from previous years
What are advantages of personal finance
This allows the owner to keep control of the business
It can reduce the amount to be borrowed from other sources
What are disadvantages of personal finance
It can be difficult to withdraw savings once they are invested into the business
There is a risk that the owner could lose their savings if the business fails
What are advantages of retained profits
This can be used to make larger purchases, such as assets or for bulk buying
The business doesn’t go into debt
What are disadvantages of retained profits
A business can find it more difficult to grow if it regularly uses retained profits, especially to solve short term cash flow problems
What is sale of assets
Selling something that the business no longer needs
What are advantages of sale of assets
Money can be raised from the sale of an asset to boost cash flow
The money does not need to be repaid
What are disadvantages of sale of assets
If the finance is required urgently, the business may have to sell the assets for less than it is worth
What is share issue?
Selling shares in the business. PLCs sell on the stock market. Lads sell shares privately
What are advantages of share issue?
Very large sums of money can be raised through sale of shares
The money does not need to be repaid
What are disadvantages of share issue?
Dividends have to be paid to shareholders
It can be expensive to advertise and organise the sale of shares
What are debentures?
Loans borrowed from individuals through the stock market
What are advantages of debentures?
Control of the business is retained
These can be paid back over a long time
What are disadvantages of debentures?
Interest must be paid annually, even if a loss is made, unlike with shares where dividends are only paid out if profit is made
What is a bank overdraft?
A facility which allows a business to spend more money than is on the bank account
What is an advantage of a bank overdraft
This is usually easy for a business to arrange with its bank
It allows a business to continue to pay business expenses despite there being no money in its bank account
What are the disadvantages of bank overdraft?
High interest rates are usually applied by the bank for borrowing money in this way
The overdraft can be withdrawn by the bank at any time and must then be repaid
What is trade credit?
Allows a business to buy goods from suppliers and pay for them at a later date
What are advantages of trade credit?
This allows a business to sell goods at a higher price and earn a profit before the bill needs to be paid
It helps the business to keep going when cash flow is poor
What are disadvantages of trade credit?
Discount for prompt payment is lost
Suppliers will be reluctant to continue to offer credit if a business does not pay within the agreed credit period
What is debt factoring
A business sells its unpaid customer invoices to a factoring company. The factoring company then collects and keeps the customers’ debts
What are advantages of debt factoring
Responsibility for collecting the debt is passed on to the factor, saving the company time and effort
Cash flow has improved by receiving an advanced payment of the debts from the factor.
What are grants?
Money is given to a business from central or local government for a specific purpose
What are advantages of grants
These are often offered as an incentive and a way of helping a business get started or expand
The money does not need to be repaid
What are disadvantages of grants?
They can be complicated to apply for and can require the business to meet certain requirements
Grants are usually one off payments that are not repeated
What is a bank loan
A bank agrees to lend a business money for a specific purpose, for a fixed period of time. Regular repayment instalments are put in place
What are advantages of bank loans
The business can budget for the repayments
Purchases of essential equipment can be made in advance and paid back over a number of years.
What are disadvantages of bank loans
Interest has to be repaid along with the loan amount
Small businesses may find it more difficult to secure a loan and often need to pay higher interest rates as they are at a greater risk
What are hire purchases
A business can buy an asset by paying an initial deposit and then monthly payments for a fixed period of time
What are advantages of hire purchases
Expensive equipment can be bought with only an initial deposit
The asset is owned by the business at the end of the repayment period
What are disadvantages of hire purchases
The business does not own the asset until the last instalment is paid
It can be an expensive form of borrowing if interest rates are high
What is a mortgage
A large sum of money borrowed from a bank or building society secured on a property
What are advantages of mortgages?
It can be paid back over a long period of time. eg 25 years
The interest rates charged is often lower than the rate of a bank loan
What are disadvantages of a mortgage
Interest has to be repaid along with the loan amount
The mortgage provider owns the property until the last repayment is made. This means the business could lose the property if it does not keep up with the repayments
What is venture capital
Organisations that invest in established business in return for equity
What are advantages of venture capitals
Large amounts of finance can be gained
Venture capitalists are more willing to take on riskier ventures
What are disadvantages of venture capitals
Venture capitalists have an equity stake, which means control and a share of profits are given up
What is crowd funding
Small amounts of money from a large number of people are raised to fund a new business or project.
What are advantages of crowd funding
Finance can be raised from individuals when banks see a venture too risky
Some funds are donated so there is nothing to repay
What are disadvantages of crowd funding
There is a low success rate
Only a low number of crowd funded ventures get off the ground
Privacy can be a problem as ideas become public and therefore can be copied
What are factors affecting sources of finance
Short term finance- Organisation may only need finance for a short term
Long term finance- Organisation may need long term finance perhaps to fund a property
Interest rates- An organisation will choose the finance with the lowest interest rates available
Payback term- The quicker the payback term the less interest the organisation will pay on borrowing
Size and type of organisation- organisations are restricted to certain sources of finance.
What is the purpose of budgeting
- To predict a positive cash flow situation (surplus)
- To predict a negative cash flow flow situation (deficit)
- To allow investment to be planned during a surplus
- To allow action to be taken to avoid a deficit
- To be compared with actual figures and used to measure the performance of individual departments or divisions
What should the business do if there is too much money tied up in inventory
Use just in time inventory control
Sell of excess inventory through a sale
What should the business do if there is too many credit sales
Offer cash discounts to encourage customers to pay by cash
What should the business do if there is too long a payment period for credit sales
Charge higher interest on credit sales to encourage customers to pay sooner
What should the business do if there are not enough credit purchases
Switch suppliers to those with interest free credit available on purchases
What should the business do if there is high amounts if spending on non current assets
Pay for non-current assets in instalments, such as paying for a vehicle using hire purchase
What should the business do if there is increasing expense costs
Look for ways to reduce expenses
What should the business do if there are too many drawings by owners
Charge higher interest on drawings to discourage owners from withdrawing money from the business
What should the business do if there are not enough sales
Adapt the marketing mix to encourage more sales
What should the business do if there are too many unpaid debts
Sell debts to debt factoring companies
What is an opening balance
The amount of cash available at the start of the month
What are the total receipts
The total cash received during the month
What is total payments
The total amount of cash spent during the month
What is cash available
The amount of cash available to spend.
Calculated by opening balance - total reciepts
What is closing balance
The amount of cash available at the end of the month
Calculated by cash available - total payments
What is the solution for cash sales falling
This could be caused by seasonal factors such as the business selling goods for suitable months only. There may also be other external factors at play, such as a recession or rising interest rates
The business should engage in marketing activities, lowering prices or launching promotions to encourage custom
What is the solution for purchases are increasing
The business is tying too much money up in inventory. The goods are not selling yet they have ordered more and more
Use Just In Time inventory control or find a cheaper supplier
What is the solution for expenses increasing
The business is paying increasing costs for expenses, for example rising rent costs
Switch to cheaper premises or sell online to cut rent costs dramatically
What is the solution for a negative closing balance
The business had a deficit in October which means their repayment outweighs their receipts. This leaves the business unable to pay off other debts and expenses
Arrange more finance in the short term, such as another loan, overdraft or attract investment.
Who uses financial statements
Owners- to assess profits and to inform decision making
Employees- to ensure their jobs are secure
HMRC- to ensure the business is paying to right amount of tax
Trade Unions- to assess if their members are due a pay rise
Competitors- to measure their success against eachother
Investors- to assess the potential for investment
Lenders- to decide whether or not to give a loan
What is sales revenue
The amount of money made from selling goods or services
What is cost of sales
The amount of money spent on selling goods
Calculated by (opening inventory + purchases) - closing inventory
What is gross profit
The profit made from buying and selling
calculated by (sales revenue - cost of sales)
What are expenses
Running costs incurred throughout the year
What is profit for the year (net profit)
The profit made after expenses are deducted from gross profit
Calculated by gross profit - expenses
What is the statement of financial position
Shows the items a business owns, known as assets, the items they owe, known as liabilities, and the overall value of the business
What are non-current assets
Items owned for a period of more than a year
What are current assets
Items owned for a period of less than one year
What are current liabilities
Items owed for a period of less than one year
What is working equity
The ability to pay short-term debts
Calculated by current assets - current liabilities
What is net assets employed
This is the value of non-current assets added to the working equity figure
Calculated by non-current assets +/- working equity
What is non-current liabilities
Long-term debts of the business
What are net assets
The overall value or worth of the business
Calculated by net assets employed - non-current liabilities
What is equity and reserves
This shows how the business has been financed
What is the purpose of ratio analysis
- Compare the performance of the business with previous years
- Compare the performance of a business to that of its competitors
- Compare against industry averages
- Highlight areas of the business that need attention
- Highlight trends to aid future decision making
What are the limitations of ratio analysis
- Ratio information is historical so is not relevant to the current or future position
- Ratios do not take into account external factors
- Ratios do not take into account internal factors, staff morale
- Ratios do not take into account product developments
- It is difficult to find competitors of the exact type and size to make valid comparisons
Explain Gross Profit Percentage
Formula: gross profit/ sales revenue x100
this measures the percentage of profit made from buying and selling. The higher the percentage, the better
How to improve % - Increase sales revenue, switch to a cheaper supplier
Explain profit for the year percentage
Formula: profit for the year/ sales revenue x 100
This measures the percentage of profit made once expenses are deducted from gross profit. The higher the better
How to improve % - Reduce expenses, increase sales revenue, improve gross profit
Explain return on equity employed
Formula: profit for the year / equity x 100
This measures the percentage of investment that is returned to investors. The higher the better
How to improve % - Attempt to increase profit for the year
What are liquidity ratios
Measure the cash situation or the business and its ability to pay its short- term debts Calculated
Explain current ratios
Formula: current assets/ current liabilities
Measures the ability of a business to pay back short term debts. The result is expressed as X:1. Over 2:1 is ideal, as it proves the business has twice the current assets as current liabilities and a healthy cash flow
How to improve % - If a business has less than 2:1, they must try and secure more current assets and reduce current liabilities. If the result is too high they should invest some current assets
Explain acid test ratios
Formula: (current assets - closing inventory) / current liabilities
Measures the ability of a business to pay back short term debts in a crisis situation. By removing inventory from the equation, the business can assess its cash flow without including the least liquid current asset
How to improve % - If a business has less than 1:1 it must secure more current assets. If its current ratio is okay but acid test is too low, it indicates too much money tied up in inventory so could implement JIT to avoid this
What is efficiency ratios
Measures how well a business uses its resources
Explain rate of inventory turnover
Formula: cost of sales / average inventory
Measures the amount of times a business restocks its inventory throughout the year
How to improve % - Most businesses want a high figure as it indicates that products are selling well and money is not tied up in inventory. If the result is too low they should use JIT to avoid overstocking.
How can technology be used when managing finance
- Presentation software can be used to engage audiences when presenting information through the use of animations and colour
- Email can be used to circulate financial information quickly
- Local area networks can be used to share documents so that different employees can assess and share information
- Internet banking can be used to make payments or check balances quickly
- Accounting software can be used to keep track of payments and income and to send invoices to customers
- EFTPOS can be used to receive money from customers instantly. Reduces need for handling cash
