Rising Finance Flashcards
What is a business?
Providing goods and services for people while generating a profit
Why do businesses need finance?
E.g. -buying stock
-paying employees
-paying rent
-paying expenses
What is a recession?
When a business has two quarters of negative growth
What is internal finance?
Finance from within a business
E.g. -owners capital
-retained profit
-sale of assets
What is owners capital?
When the owners of a business use their own personal servings to invest into the business
Benefits of using owners capital
-If owners have a lot of savings it can be quick
-Don’t have to pay it back
-Can invest it whenever
Drawbacks of using owners capital
-Possible low amount of finance raised
-Owner may not have the money
-Risk of personal debt
What is retained profit?
When a business reinvests its profits to help it grow
(well known businesses reinvest yearly for stock, staff, vehicles, premises and equipment)
Benefits of using retained profit
-Easy if the business has high profits
-It is free to reinvest
Drawbacks of using retained profit
-May not have enough profits to reinvest
-Owners are missing their share of the profits
What is sale of assets?
Raising finance by selling items the business already owns
E.g. -machinery
-land
-premises
-vehicles
Benefits of using sale of assets
-Making room
-If unused, making money from it rather than having it sitting around
-Cheaper final product because you sold the old one
Drawbacks of using sale of assets
-No longer have the asset
-May take a long time to sell
What aspects of finance should be considered in a business plan?
3 major components:
-cash flow projection
-income statement
-balance sheet
Must also outline past, present, future financial state (includes:)
-expenses
-cash flow statement
-break even point
-sales forecast
What is a business plan and why are they important?
A look into the future of a business
-prevent risk and failure
-set goals and targets
-used to apply for finance
-monitor success
-attract possible investors
What will a cash flow forecast show?
The expected income and expenditure of a business over the coming year
What will a start up cash flow management show?
The start up money (this is why many businesses fail)
What will the affordability of interest show?
It will include cash flow forecasts which show banks the interest rates that can be afforded on the finance they borrow
Interest rates
the base rate is set by the Bank of England which is independent from the government
What is a cash flow forecast?
A prediction of the amount of money that will flow into and out of the business
Includes:
-cash inflows
-cash outflows
What are cash inflows?
Money coming into a business (receipts)
E.g. -sales revenue
-loans
-grants
-selling shares
What are cash outflows?
Money leaving a business (payments)
E.g. -buying stock
-paying expenses
-repaying loans
-buying equipment
How do you calculate the monthly balance in a cash flow forecast?
Total inflows - Total outflows
How do you calculate the closing balance in a cash flow forecast?
Monthly balance - Opening balance
Why do businesses make cash flow forecasts?
-Make comparisons between predictions and actual
-Help control and monitor cash in and out of a business
-Important for financial planning (can support an application for funding)
-Show owners where cash flow shortages are likely so they can arrange suitable finance
Factors affecting cash flow
-Consumer trends (can increase or decrease sales)
-Economic variables (if the economy is in a growth or decline sales and costs will be impacted)
-Competitors actions (new products, innovation, reputation gain)
Problems with cash flow forecasts
-Bias (may have overinflated inflows to improve business reputation and impress suppliers)
-Prediction (cannot see all future events)
-Static document (needs updating regularly or it becomes old and outdated)
-Short term (only a 12 month snapshot)
-Shows no profit only cash
What is limited liability?
Not liable for the debts of the business, can only lose the money invested
-Includes public or private limited companies
What is unlimited liability?
Responsible for debts of the business, may have to sell personal assets to pay the debts
-Includes sole traders and partnerships
What is gross profit and how is it calculated?
The selling price of a businesses profit without the cost of producing it
-The higher the better, can be compared yearly and measures the performance of a business
-Calculation: sales revenue - cost of sales
What is operating profit and how is it calculated?
The sales revenue without the operating expenses of a business
-Calculation: gross profit - expenses
What is net profit and how is it calculated?
It is what the business has left of its sales revenue after paying all of its debts
-The higher the better and demonstrates how well a business is controlling their expenses
-Also known as profit before taxation
-Calculation: operating profit - expenses
What is gross profit margin and how do you calculate it?
Allows a business to see their gross profit as a % of their sales
-Calculation:
(gross profit / sales revenue) x 100
What is operating profit margin and how do you calculate it?
It is a true measure of profit
Calculation:
(operating profit / sales revenue) x 100
What is net profit margin and how is it calculated?
The proportion of sales revenue that is left once all the costs have been paid
-Calculation:
(net profit / sales revenue) x 100
Why are profit margins a better indicator of performance than the raw figures?
-Allows comparison because it is a % not a rough figure
-Calculated after expenses
What is the break even point and how is it calculated?
Where the total costs are the same as total revenue, the business is making neither a profit nor a loss
-Calculation:
total fixed costs / contributions per unit
How are total costs calculated?
Fixed costs + Variable costs
What is revenue and how is it calculated?
The money coming in from sales
Known as sales or turnover
-Calculation: selling price x units sold
What are fixed costs?
Don’t vary with output or sales e.g rent
What are variable costs?
Change depending on output e.g stock
How do you calculate contribution?
Selling price - Variable costs per unit
What is the margin of safety?
The difference between the actual level of output and the break even output
Limitations of break even
-It assumes that every item produced is sold
-In a service business the prices may differ
-Costs may increase and you would need to recalculate the break even
-It is only a best guess of what might happen
What is a budget?
A financial plan and an agreed spending limit within a business
-based on objectives
-managers must think ahead
-usually 12 months
Why do businesses create budgets?
-Planning (allows them to anticipate problems and develop solutions)
-Motivation (managers feel responsible by being in control)
-Control (budgets are set against aims and can be used as a comparison goal for success)
What is a historical budget?
A budget set using current figures (how much you will spend, sell, costs)
-Pro: it is realistic as it is based on last years sales
-Con: these things are dynamic and may be wrong
What is a zero based budget?
A budget set using figures based on potential performance, it takes away historical assumptions and starts on a clean slate
-you must be able to justify the levels of expenditure
-Pro: clean slate
-Con: must be loud and convincing to receive a higher budget
Benefits of a budget
-Provides a method to allocate resources
-Monitor and control operations
-Promotes forward thinking and planning for the future
-Motivate the workforce and show employees the overall picture of organisation
Limitations of a budget
-Can sometimes be too low and some departments end up lacking in resources
-Time consuming to create
-Possible errors
-Budgets involve and affect people which can cause conflict
What is variance?
When you compare the budget figures against what actually happens, it happens in 2 ways:
-favourable variance
-adverse variance
What is favourable variance?
The manager has under-spent in the department, this means success for the budget as the costs have been cut which will impact profits
What is adverse finance?
The manager has overspent, profits will be lowered as costs are now higher
Difficulties of budgeting
-Often fixed for a year, this is difficult when a business is dynamic
-Time consuming to monitor, prepare and control
-Can be demotivating if the budget is unrealistic
-Can cause inter-department rivalry
What is a profit and loss account?
A financial document showing the company revenue income over the year as well as their costs and expenditure
-created at the end of the trading year
-provides a summary of profit or loss during the year
Why are profit and loss accounts useful?
-Shows money going in and money going out
-Allows a company to quickly identify if they are making a profit or a loss
Methods to improve a business’s profitability
-Increase revenue e.g raise the price
(can be risky as sales may be impacted and demand may fall)
-Reduced costs e.g move countries, find cheaper raw materials, make redundancies
What is profit and how is it calculated?
-Shows how much money is left after expenses
-It is recorded immediately after a sale
-Calculation: total revenue - costs
What is cash?
The most liquid of assets
-needed to survive
What is liquidity?
The ease at which an asset can be converted into cash
-this is measured to understand how secure a business is
What is a balance sheet?
A document showing what a business owns (assets) and what it owes (liabilities), it essentially shows how much a business is worth
-it is a snapshot of what a business is worth over a period of time
-shows sources of funds and how a business uses them
-is also sometimes known as a statement of financial position
-public and private limited companies must publish these by law
What are non-current assets?
These are fixed assets that will be kept for more than one year, they are long term assets of a business which are not expected to be sold within the next year of trading
What are current assets?
Assets a business will be getting rid of throughout the year, they are short term assets which are likely to be turned into cash within the next year of trading
What are non-current liabilities?
Debts which are not expected to be paid off within the next year of trading
What are current liabilities?
Debts which are expected to be paid within the next year of trading
Uses of a balance sheet
-Evaluate the performance of a business
-Evaluate the potential of a business to an investor
-A summary evaluation of a business
Limitations of a balance sheet
-Value of the assets stated may not be the same as the amount they actually sell for
-A statistic snapshot of one day in a business, this picture could change the next year
What is current ratio and how is it calculated?
A measure that estimates whether the business can pay its debts due within one year out of its current assets
-Also known as working capital
-Calculation:
current assets / current liabilities
What is the acid test ratio and how is it calculated?
Known as the ‘quick’ ratio and is a much harsher test of liquidity because stocks aren’t guaranteed to sell
-Calculation:
(current assets - stock) / current liabilities
What is working capital and how can it be calculated?
The funds that a business has to meet it day-to-day expenses
-Calculation:
current assets - current liabilities
How can a business improve liability?
-Reduce the amount of stock that the business holds
-Reduce the credit period offered to customers
-Pay suppliers later on agreed credit terms
-Increase borrowing long term and clear the short term debts
Examples of sources of finance
-Family and friends (selling them shares)
-Banks
-Peer to peer funding
-Business angels
-Crowdfunding
-Other businesses
Examples of methods of finance
-Loans
-Share capital
-Venture capital
-Overdrafts
-Leasing
-Trade credit
-Grants
What is external finance?
Funds obtained from outside the business
What are the benefits of using external finance?
-Speed up growth
-Provide emergency relief
-Support uneven cash flow
-New equipment
-Replenish supplies
What are the limitations of using external capital?
-Can sometimes have high interest costs
-Possible loss of ownership
-Debt obligations
-Can cause cash flow issues
What is family and friends finance and what are the pros and cons?
Includes:
-Selling shares in an LTD
-Contributing money
Pros:
-Owner keeps control of the business
-Owners have better trust with their business investors
Cons:
-Can cause tensions/problems if money isn’t repaid
What is bank finance and what are the pros and cons?
Includes:
-A loan (typically to start up businesses)
-An overdraft when a business has cash flow issues
-A mortgage loan
Pros:
-Quick and easy for short term finance
-Can receive a large sum of money
Cons:
-Overdrafts can be expensive as they have a high interest rate
-All methods must be paid back with interest
What is peer to peer funding and what are the pros and cons?
It is an unsecured loan without going through a bank
-e.g student loans, payday loans, debt factoring (selling a loan on) and lease agreements
Pros:
-Lower interest rates
-Borrowers can earn a credit rating
Cons:
-High credit risk
What is angel investment and what are the pros and cons?
This is where an angel investor uses their personal disposable income and gives it to a business for them to use
-(Sometimes also known as equity finance)
-Many usually want shares in return
-The investors provide knowledge and experience as well as finance
-Usually want a return on their investment within 3-8 years
Pros:
-Provide money, knowledge and experience
-Often do not need to be repaid with interest
-Everyone is eligible
Cons:
-Possible loss of control and ownership
What is crowdfunding and what are the pros and cons?
It is where a large number of people fund a project over the internet making small investments each
Pros:
-Usually have many investors so lots of finance is raised
-Can help build a customer base
-Business can avoid the debt and interest of a bank loan
Cons:
-May have expensive returns
-May not reach the target amount of finance
-Can be time consuming to promote your campaign
Ways to crowdfund
-Donate: investors get no money back, may receive tickets or newsletters in return
-Lend: money is paid back to investors with interest
-Invest: in exchange for equity or shares
What is a bank loan and what are the pros and cons?
A transfer of money from one party to another with an agreement to pay it back
Pros:
-Allow growth
-Keep full control
-Quick
Cons:
-Expensive to pay it back with interest
-Possible high interest rate
What is share capital and what are the pros and cons?
When a business raises finance through selling shares
Pros:
-No interest payments
-Low risk
Cons:
-Share dilution impacts existing share holders
-Possible loss of control and ownership
What is venture capital and what are the pros and cons?
When money is invested into a project where there is risk
Pros:
-Can achieve a large amount of capital
-No obligation to repay
-Offers an opportunity for expansion
Cons:
-Possible loss of control and ownership
-Difficult to come across
-Can be expensive if it needs to be repaid
What is an overdraft and what are the pros and cons?
An agreement with the bank to spend more money then is in your bank account
Pros:
-Can take more money if needed
-Flexible
-Cheaper than a loan as you only take out what you need
Cons:
-Must be repaid with interest
-Possible high interest rates
-Bank can reduce or cancel the overdraft at any time
What is a lease and what are the pros and cons?
An agreement for a user to pay the owner for the use of an asset e.g property
Pros:
-Lower monthly payments
-No down payments
-Low initial investment
Cons:
-No ownership
-Possible termination liability
-End of lease costs (wear and tear)
What is trade credit and what are the pros and cons?
Buying goods on credit (paying the supplier late for the stock)
Pros:
-Delay payments until you have more money
-Allows growth
Cons:
-Greater risk for debts
-Possible tension if unable to pay
What are government grants and what are the pros and cons?
A sum of money awarded from the government that you don’t have to pay back
Pros:
-Don’t have to repay
-No debt
Cons:
-Restricted income
-Highly competitive to get
-Unsustainable as they are short term
What is sales volume and how do you calculate it?
The total amount of goods/services sold over a certain period of time
Calculation: number of units sold x time period
