Section 5 - Finance (Chap 22 - 26) Flashcards
note: don’t say money, uses finance/ capital
eg of need for finance
-make new products
-pay fixed costs
-start new business
-advertising
-maintenance of machines
-buy raw materials
-insurance
-relocation
3 needed for finanace
1)Expand existing business/ Start up capital - finance required to start a new business
-low frequency of need
-need most money
-long term
2)Capital expenditure - purchasing assets (machines & tech)
-low frequency of need
3)Working capital - finance needed for day to day running of business
-high frequency
-need lest money
4) Revenue expenditure
note: bank never gives full amount asked for
types of sources of finanace
1)Internal = finance raised from inside the business
-can’t raise a lot
-don’t need to be repaid’
-no charge
-not in debt - business can’t be controlled by others
-has a limit to how much money you can make
eg, selling objects, raising prices
2)External = finance that comes form outside the business
-have to pay charge & return money after some time
-in debt = gives up control of business
-no limit to amount of money that can be earned
eg, bank loans, overdrafts
types of external finance
1) short term - finance that has to be paid within a year
eg, cheap things
2)medium term - finance that has to be paid in a couple of years
3)long term - finance that has to be paid after a long time
eg. expensive things
Sources of internal finance
1) retained profits = profit after paying tax & dividends
-don’t have to be repaid
-no charge
-only for established businesses
-shareholders are unhappy if you don’t give them more profit
2) sale of unwanted assets & use money to buy other things
-better use of capital
-sell second hand - don’t get full price as before
-have to buy again if need item
-not sold immediately
3) Sale of inventories to reduce inventory level
-reduces opportunity & storage costs oh high inventory levels
-there may no be enough good for customers
4) Owner’s savings = owner puts in personal money
-no charge
-saving may be too low
-increases risk to owner - unlimited liability
Sources of external finance
1) Sell shares
-no need to repay capital
-no charge
-dividends are expected by shareholders
-loss of control
2) Bank loans
-can be for varying period of time
-large business get lower bank rate when borrowing a large sum
-repaid with charges
-need a collateral = bank owns a property if business can’t repay money
3) Debentures = shares but you have to pay back with charge
-can raise money for long term
-have to repay with interest
4) Grants = money given by gov to help the business
-no charge
-don’t have to return money
-only gives it it helps society
eg, located in remote area to give employment there, make products that help preserve culture
Sources of finance in short term
1) trade credit = buying on credit = paying supplier after selling goods
-only for goods, not services
-no charge unless delayed payment
-suppliers may not be able to collect money on time
-supplier refuse to give discounts
2) Bank overdraft = businesses can withdraw more money than the amount of money in their account
-has high charge since risky for bank
-have to pay on demand
-interest only on the amount overdrawn
-in debt = lose control
3) Debt factoring
Sources of finance in medium term
1) higher purchase = pay down payment & installments
-has charge
-use machine to generate income to pay installments
-can immediately start earning om after buying machines
-company can repose assets if installments aren’t paid; insurance on assets in case
2) Leasing = renting something
-never have full ownership of the rented asset
-insurance on machine is done by leasing company
-total cost of leasing is higher than buying the machine
3) Bank loan = borrowing money from the bank
-need to show why business needs the money
-lots of paperwork
-banks are at risk
-cheap interest
Sources of finance in long term
1) shares
-only for Pub Ltd company
-can get lots of money by people buying that shares
-no need to repay capital
-no charge
-dividends are expected by shareholders
-loss of control
-no need to give dividends
2) Debentures = shares but you have to pay change & money back
-no ownership loss
-can get lots of money
-can raise money for long term
-have to repay with interest
-lots of paperwork to prevent fraud
3) mortgage
-giving land to a bank and if you can’t pay back, bank takes the land
-higher purchase when buying a hose: pay mortgage in installments for a long time, full ownership once full payment
Other sources of finance
1) Grants = money given by gov to help the business
-no charge
-don’t have to return money
-only gives it it helps society
eg, located in remote area to give employment there, make products that help preserve culture
2) Subsidy = money given by gov to help lower selling prices
-helps local business compete with foregin businesses
-only for necessary goods eg, petrol, electricity
-gov. bears the loss
-no need to pay back money
-no charge
3) Micro finance = provide financial services to poor people who are not served by the bank
4) Crowd Funding = funding by raising money from lots of people who each contribute a little amount
-little money from each person accumulates
-need publicity to increase chances of it working
-if target money isn’t raised, money has to be repaid
5) business angels = people who anonymously invest in other businesses to get a profit
define micro financing
provide financial services to poor people who are not served by the bank
define crowdfunding
-funding by raising money from lots of people who each contribute a little amount
factors affecting which finance to take
1) purpose = what the money will be used for
2)time period = how long you need money for
3)amount of money needed = large or small
4)type of business size = eg. sole trader, Pub Ltd
5) Control = lose control of business or not
eg, sole trader converting to partnership, getting a bank loan
6) risk & gearing = to what extent the business is funded by borrowings
-shouldn’t rely on borrowed funds too much = risky
-if you continue borrowing without paying back, less likely to get loans
-safer to be low geared
define cash flow forecast
predicting cash coming in & out of the business during a period of time
-physical cash, not credit
-need inflow to be greater than out flow
-not reliable, just a perdiction
define
-cash flow
-cash inflow
-cash outflow
cash flow - cash in & out flow during a period of time
cash inflow - money received by business during a period of time
cash outflow - money paid out by business during a period of time
examples of cash in flow
-donations
-loans
-sales
-sales of assets
-shareholders money
examples of cash out flow
-purchasing goods
-salaries
-rent
-electricity
-repaying loans
define cash flow cycle
stages btw paying cash out and receive cash
cash flow cycle
-buy raw materials
-make finished products
-sell goods
-receive cash & start again
-quicker the cash flow, the better
-should not run out of cash, else bankrupt & debt
note: cash flow isn’t the same as profit
define profit
money after total costs is deducted form revenue
revenue - total costs
formula for net cash flow
total in flow - total out flow
formula for closing cash balance
net cash flow + opening cash
define
-net balance
-opening cash
-closing cash
net balance - difference in inflow & outflow
opening cash - money held by business at the start of the month
closing cash - money held by business at end of the month & is opening cash for the next month
note: for cash flow forecast, write ( - ) numbers in brackets
eg. -300 = (300)
features of a cash flow forecast
-inflow, outflow, balance, Net cash flow, opening cash, closing cash
-closing cash should never be ( - ) = debt
-opening balance = money at the start of opening the business in that time
note: if need to make cash flow forecast better:
-recue outflow, increase inflow
-take a loan
how to draw a cash flow forecast
-write the diff. months
-list all the cash inflow
-find total cash inflow
-list all the cash outflow
-find total cash outflow
-find Net cash flow [total in flow - total out flow]
-Opening balance
-Closing balance [net cash flow + opening cash]
-the Closing cash of the pervious month is the opening cash of the next
uses of a cash flow forecast
1)can plan based on prediction
eg, budgeting
2)getting a bank loan = banks need to see if business can generate enough money to pay them back
-how much money needed from bank
3)managing cash outflow
eg. loans
just a prediction, only gives outline
how to solve a cash flow problem
1)Get a bank loan
high inflow in a month, installment outflow afterwards with charge
2)Delay payment to suppliers
eg, outflow of that money can be outflow of next month
no discount next time, get angry & refuse to supply, might have to pay more
3)Ask customer’s to pay quickly
more inflow, angry customers buy from others = less sales
4)Delay purchase of equipment so less outflow for that month
5)Sell more shares - more capital, less control
define working capital
money needed on a day to day basis
diff btw credit sales & cash sales
credit sales - buy now, pay later
cash sales -immediate cash
define creditors & accounts payable
creditor - people you have to pay back after buying from them on credit
accounts payable - the person who has to pay back money after buying on credit
-an outflow/ liability
define capital expenditure
money spent on non- current assets which last over a year
define revenue expenditure
working capital which does not include purchasing long term assets
eg. rent, wages
until here is done from the book
what does an income statement do
accounts on business’s incomes and expenses for 12 months to figure out of the business made a profit or loss
formulas for income statements
1) profit = revenue - expenses
2) gross profit = revenue - cost of sales
3) net profit = gross profit - expenses
4) retained profits = net profit - dividends - tax
features of an income statement
-revenue (cash + credit)
-cost of sales (cost to produce the goods)
-gross profit (revenue - cost of sales)
-expenses eg. taxes, electricity, salary, rent
-net profit (gross profit - expenses)
-dividends - profit given to shareholders
-tax to gov,
-retained profits (net profit - dividends - tax)
define account
financial records of a business
define statement of financial position
shows value of business’s assets & liabilities in that day (last day of the accounting year)
define assets, non- current assets & current assets
assets - items owned by business
non- current assets - assets owned by a business for over a year
eg. furniture, building, equipment, land
current assets - assets owned by a business for less than a year
eg. inventory (stocks), debtors (own money to us), cash
define liabilities, non- current liabilities & current liabilities
liabilities - debts owned by business
non - current liabilities - debts owned by business for over a year
current - liabilities - debts owned by business for less than a year
define shareholder’s funds
capital raised from shareholders = shareholder’s equity
define retained profits
profit kept for emergency use
formulas for statement of financial position
1) capital = total assets - total liabilities
2) shareholder’s funds = share capital + retained profit
features of statement of financial position
-non- current assets
-current assets
-total assets
-non- current liabilities
-current liabilities
-total liabilities
-capital (total assets - total liabilities)
-share capital
-retained profits
-shareholder’s funds (share capital + retained profit)
2 away to analyze accounts
1) profitability
2) liquidity - ability of a business to pay back its debts
profitability ratios - higher the better
1) Gross profit margins
2) net profit margin
3) return on capital employed (ROCE) - getting returns after investing in the business
formula for gross profit margins
gross profit
———————————– X 100%
revenue/ sales in a year
-gross profit = sales - cost (salary not included in costs)
-revenue = no. sales x selling price
formula for net profit margin
net profit
———————————– X 100%
revenue/ sales in a year
-revenue = no. sales x selling price
formula for return on capital employed (ROCE)
net profit
———————————– X 100%
capital employed
-capital employed = money invested in the business
methods of comparison for analysis of accounts
1) inter business - within the the business
2) Intra business - with other business
liquidity ratios
1) Current ratio
2) Acid test ratio
formula for current ratio
_______ : 1
current assets
———————–
current liabilities
-current assets - inventories, accounts receivables, cash (order of liquidity)
-current liabilities = accounts payable, bank overdraft
-ideal ratio: 2 : 1
formula for acid test ratio
_______ : 1
current assets - inventories
——————————————
current liabilities
-ideal ratio: 1 : 1
uses of accounts
1) show the state of the business
2) compare with other business
3) shows financial stability
users of accounts
P = profitability
L = liquidiity
1) managers - run the business (P)
2) shareholders - how much dividends will be paid (P)
3) workers - can ask for raises (P)
4) competitors - compare accounts (P)
5) banks - if business can pay back loan or not (L)
6) creditors (accounts receivable) - if business can pay back (L)
7) gov. - taxes, if business is legal (P/ L)
limitations of accounts
1) no qualitative aspect; data can be manipulated
eg. when product gives reputation even if product has low sales
2) no exact standard way to prepare accounts
3) data collected is not always right
4) if data is false, bad predictions are made
