September exams Flashcards
what is finance?
the management of the investment needed to open, run and grow a business
what are 3 reasons for raising finance?
- to help a business over a slowing trading period
- to expand
- to start-up
what are two methods of raising finance for the short term?
bank overdraft
trade credit
what are two methods for raising finance for the medium term?
bank loan
leasing
what are four methods of raising finance for the long term?
owners’ savings
sales of shares
reinvested profits
venture capital loans
what is internal finance and what are the 4 ways?
this is money that comes from inside the business
retained profit
sales of assets
owners capital: personal savings
Improved management of working capital
explain the internal finance method of owners capital and its pros and cons
- This is the money put into a business by its owner or owners. This is often used when a business is first set up
- it is sometimes called the owners’ equity
- it represents the net assets of the company and the stake the owner has in the business, if all debts were paid off it is how much which would be owed to the owner
- This is limited as not many will have the sufficient fundings in order to successfully rely solely on this
pros:
- no repayment required, allowing for more spending flexibility
- lower risk
cons:
- not available for all businesses, relies on a stable economic stance
- could put a strain on your family and personal life
appropriateness:
- sole traders and partnerships
explain the internal method of retained profits and the pros and cons
- this is the profit made by the business in earlier years. It is the money kept in the business rather than paying it out as dividends.
- it is the best way to finance investment into a firm’s future
- logically then, the higher the profit the more likely it is that it can finance its expansion from within
positives:
- no interest to pay
- they are very flexible, they have complete control over what proportion is kept rather given as dividends
negatives:
- once it is used it cannot be used elsewhere in the business, it is gone
- danger of hoarding cash rather than investing
appropriateness:
- if a business is in its first year of trading it will not have any retained profit
- if a business has not been profitable then there will not be any retained profit to spend
explain the internal method of sales of assets and its pros and cons
- This is using a business’ assets and selling them off. They may say buildings, land, vehicles and machinery that is no longer needed
- the business that sells the asset will no longer have the benefit of that asset and it will not appear on the balance sheet of the company, meaning the business will look less attractive to investors
pros:
- it is a quick way of upgrading and making cash, 0% interest
- assets (like a van) can be sold quickly for cash
cons:
- risky may be needed later on, cause future problems
- reduce the number of assets belonging to a business, lower value
- it may not raise enough money for growth or expansion
appropriateness:
- all types of business can sell their assets
- it may not raise enough money for growth or expansion
- depends on how well run is the business if they need to sell their assets
what are the 6 sources of external finance?
family and friends banks peer-to-peer funding business angels crowd funding other businesses
wha tare the 7 methods of external finance?
loans share capital venture capital overdrafts leasing trade credit government grants
explain the external source of finance of family and friends and what are the pros and cons
- they can provide share capital (through the selling of shares) or can lend money
- a sole trader or partnership may find that their family want to contribute to the business. this may be for interest, a share of the profits or maybe even an interest free loan amongst family
- the majority of businesses start with a combination of owners’ capital and family and friends
pros:
- loans from family and friends will probably be offered without the need for security and at lower rates and over longer terms
- they are unlikely to need a business plan and so can save the time of not wiring one
cons:
- You may feel pressure on the relationship, what happens to the friend or member of family will affect them
- they may demand their money back at short notice
explain the external source of finance of banks and their pros and cons
- banks may lend a loan to a business to start-up or when a business wants to grow and expand
- borrowing a large sum of money to pay interest on the money you owe
- banks may also provide a business with an overdraft to help hen they have cash flow problems
pros:
- repayment plans available to suit the business
- banks will allow the business to continue running in their own way, not interfere, owners retain control of the business (unlike business angels)
cons:
- if it is a start-up business then the owner may need to use their own assets as security for the loan (e.g. their house)
- loans can be very expensive compared to other sources, interest must be paid back on time
explain the external source of finance of peer-to-peer funding
- matches businesses that need funding with investors who are looking for a good return on their investment
- this was very popular after the 2009 recession when banks were reluctant to lend money
- lending marketplaces such as funding circle have gained the trust of consumers by offering lower rates than banks to business owners who want to borrow money
pros:
- investors can expect returns of 6-7% whereas a savings account might only give them 3%
- it is unsecured and so borrowers do not need to give collateral as security
cons:
- if there are not enough individuals interested or willing to invest in your loan, you may not be able to acquire the entire amount that the business needs
- the money for the loan comes from several investors, it is classified as a private business loan so you are tied up with several companies
- businesses can’t access to funding within a week once approved
explain the external source of finance of business angels and its pros and cons
- Individuals who invest in the early stages of a riskier business and take an equity share in return for providing finance, advice and guidance, normally established
- an angel investor offers to lend their personal disposable income, normally in exchange for shares in the business
- angel investors take huge risks in the hope of an occasional blockbuster success, DRAGONS DEN
- usually smaller loan amounts than a venture capitalist
pros:
- the owner gets access to angels’ mentoring and management skills
- the owner will have no repayments or interest on the money lent
cons:
- owner needs to give a share fo the business
- not suitable for investments below £10,000 or above £500,000
explain the external source of finance of crowd funding
- a way of getting small investors to put money into a new product over the internet, go fund me page
- the three ways to fund are through:
1) donate- no money back but rewards like tickets or free samples
2) lend- gets money back with interest and satisfaction of contributing to success of a small business
3) invest- invest tin the business in exchange for equity or shares which may go up in value - it is more successful when the sponsors use social media to promote their firm
pros:
- the business can generate funds and also promote the business at the same time
- good alternative to loans for small business owners
cons:
- the firm will need to showcase their idea to investors and may need to put together a video and other promotional material, cost
- takes much longer to happen than a loan, is not always successful, often doesn’t raise enough
explain the external source of finance of other businesses
- some large MNC’s are willing to invest in innovative start-ups, the companies hope to get the occasional winner among a number of duds
- In Silicon Valley, USA, this type of investment is common, but not in the UK
what is an external source of finance
if the business is unable to generate sufficient funds from internal sources then it may need to look to external sources. there are two sources of external capital: loan capital (debt) and share capital (equity).
- loan capital carries interest rates and must be repaid in a specific time schedule
- share capital is usually rewarded by annual dividend payments, but the directors have the flexibility to cut or scrap those payments in a difficult year
explain the method of external finance of loans and its positives and negatives
- loaning money from a bank is like ‘renting’ money
- banks will lend to small businesses but may not lend when they first start-up as there is no track record or history of them making money
- The loan is set for a period of time, either being short, medium or long term. It can be paid in instalments or at the end of the period. The bank will ask for collateral to provide security if the loan cannot be repaid.
- loans are affected by interest rates- if they go up then the cost of borrowing will go up too
Positives:
- Easy to do and repayment plans available to suit the business
- as the loan is fixed for a certain length of time, the firm can produce a successful cash flow forecast, they know when and how much money will go out the business
Negatives:
- They may ask for collateral- an asset belonging to the business so is risky
- if interest rates go up then it can become an expensive source of finance
- can face high interest rates if not paid back on time and so can become an expensive source of finance
explain the method of external finance of share capital and what are the pros and cons?
- this is when a PLC makes money from the selling of shares
- If the business is a limited company, it may look for additional share capital, it can come from private investors or venture capital funds.
- Once it has become a public limited company, the firm may consider floating on the stock exchange.
Positives:
- investors are often prepared to provide extra funding as the business grows
- it can bring wise heads into boardroom
Negatives:
- the more shares sold, the more the profits have to be divided up and paid out to investors as dividends
- potential investors may require a great deal of background information before the buy the shares
explain the method of external finance of venture capital and what are the pros and cons?
- Venture capitalists invest in smaller, riskier companies with a large sum of money but in return they demand a substantial part of the ownership of the company.
- they will look for a high rate of return in a specific time period
- it is good for any start-up or early stage business that is unable to raise finance through the stock markets or from banks
- they will invest at least £50k but this can rise into millions of pounds
Pros:
- useful if the business is looking to raise a large amount of money in a short space of time, banks would not offer this
- Venture capitalists can provide advice, expertise and contacts
Cons:
- venture capital firms typically want a 20-30% stake in the business
- venture capital firms look for a strong business plan and a proven track record, making it difficult for start-up firms
explain the method of external finance of overdrafts and its pros and cons
- An overdraft is a very short-term loan. it is a facility that allows a company to spend up to an agreed negative balance on its current account, it is ‘extra cash available’
- it may be organised by the bank which is short term lending of smaller amounts of money
- once it is arranged, it is an account business can dip Inyo or pay it back as they see fit
Positives:
- seen as a quick fix method to help a business over a difficult month of trading, very flexible, suited to the difficult cash flow position of start-ups
- the business will only pay interest on the amount of money that they are overdrawn, easily pay back the overdraft
Negatives:
- very risky, banks can cancel them at any time, often leading to the business not being able to repay the negative balance, leading to administration
- very expensive source of finance, higher interest rates than loans, high charges
explain the method of external finance of leasing and what are the pros and cons?
- Leasing an asset means agreeing to pay a fixed monthly rental for a fixed period, such as three years
- You end up paying more than what the product is worth but at least you have kept the cash in your bank account at the start of the period
- In the long term, leasing is more sensible than buying the asset in terms of your cash flow
pros:
- improves cash flow as it comes out in small amounts, not a shock for the business
- allows you to buy more expensive equipment due to the repayment plans
negatives:
- pricey, in the long term it is more expensive
- needs to hope that they continue earning enough to repay
explain the method of external finance of trade credit and what are the pros and cons?
- When a business obtains goods and services from another business but does not pay for these immediately
- Suitable for businesses buying raw materials and stock, the buyer will have time to sell their goods in their own shop before they have to pay for them
- the wholesaler may give the buyer a discount when they use cash instead
Pros:
- no interest has to be paid on trade credit
- businesses that pay regularly on time build relationships with their supplier and secure better deals
Cons:
- if the business doesn’t pay on time then they risk being refused further credit by the supplier in the future
- not all stock is available to buy on trade credit, only applies to certain industries
explain the method of external finance of government grants and what are the pros and cons?
- they are hand-outs to small firms, often in areas of high unemployment. they are given to encourage a start-up or a relocation that is considered as valuable
- they are only available to businesses that qualify, e.g. if they are providing jobs in an area of high unemployment or helping people develop skills
Pros:
- the business will not have to pay back the grant, no interest
- can be used to aid growth and increase revenue
- they will get funds without any loss of control of the business
Cons:
- there’s a lot of competition for grants, difficult to obtain one, need a successful proposal
- Often just a one-off payment, short-term
what are the 4 methods of production?
job
batch
flow
cell
what is job production?
when the complete task is handled by a single worker or group of workers. This is a bespoke service and is tailor-made to suit the specific requirements of the customers.
what are the characteristics of job production?
- e.g. designer products
- unique
- labour-intensive
- high-skilled
- high value
examples:
- architects
- plumbers
what are the pros and cons of job production?
advantages:
- product usually high quality, premium price
- greater job satisfaction, involved in all stages of production, more motivated
- customer requirements and changes can be handled, USP, specialisation, loyalty
disadvantages:
- often labour intensive so high labour costs
- labour intensive, may need motivational incentives
- requires investment in skills and training
- requires close consultation with client, a lot of time
what is batch production?
this requires that the work for any task is divided into parts or operations and produces a set of identical items. it usually involves division of labour whereby tasks are divided between employees. they concentrate skills on each part of product process through specialisation.
what are the characteristics of batch production?
- used in the production of electronics
- concentrate skills (specialisation)
- e.g. food industry
- better use of equipment, produce more economically than manufacturing individually
what are the pros and cons of batch production?
advantages:
- producing in batches reduces unit costs, higher profits, benefit from E.O.S
- use of specialist machinery and skills can increase output and productivity
- companies only focus on a small group of products, leading to greater quality control and product expertise
disadvantages:
- requires the business to maintain higher stocks of raw materials and work in progress
- potentially de-motivating for staff due to the lack of variety, very repetitive, lower productivity
- each batch must be tested for quality and uniformity before future batches, loss of time, machinery may need to be reset
what is flow production?
a method where the task is worked on continuously or where the processing of material is continuous and progressive. it is the most efficient way to produce an idea with predictable, high-volume sales. it is highly automated and capital intensive, when one task is finished the next task must start immediately.
what are the characteristics of flow production?
- very quick and efficient
- e.g. car industry
- highly automated, capital intensive
- economies of scale
- identical products
what are the pros and cons of flow production?
advantages:
- very low costs per unit due to economies of scale
- output can be produced very quickly, high efficiency and productivity
- production speed can vary according to demand as it is capital intensive
disadvantages:
- very high set up costs due to the large amount of machinery
- workers motivation can be very low due to repetitive tasks
- lacks differentiation, all the same, often lower quality
- production is shut down if flow is stopped
what is cell production?
this is flow production but split into a number of self-contained units. each team or ‘cell’ is responsible for a significant part of the finished article leading to flexibility, division of labour. team members are skilled at a number of roles. the teamwork often leads to higher productivity and higher output levels. it is communication based, involves team work, specialisation and motivation
what are the characteristics of cell production?
- team work
- communication-based
- specialisation
- high productivity
- division of labour
what are the pros and cons of cell production?
advantages:
- workers become multi-skilled and more adaptable to the future needs of a business
- greater work motivation, arising from a variety of work, team working and more responsibility
- quality improvements as each cell has ‘ownership’ for quality on its area
disadvantages:
- the culture needs to encourage trust and participation as otherwise they can feel that they are being constantly pushed for more
- may not allow firms to use their machinery as intensively and so output will be lower
- there may be rivalry between different cells and conflict may arise if one cell is let to wait for output from another
what is labour productivity?
measures the amount a worker produces over a given time.
what is the formula for productivity?
outputs / inputs per time period
what are the benefits of high productivity?
- a firm can improve its competitiveness by either selling their products at a lower price or keep the price as it was and enjoy a high profit margin
however they need to make sure that with increased productivity that they are maintaining the same quality
what are the factors to consider before deciding their method of production?
- nature of the product
- volume needed
- degree of competitive rivalry
- expectation of consumers/quality
what are the factor affecting productivity?
- the level of investment in modern equipment (robots can work 24/7 without rest)
- the ability level of those at work (training)
- improve employee motivation
- labour shift organisation of workers (having right number on peak times will improve productivity, stretched staff are demotivated by being overloaded
explain the factor affecting productivity of the level of investment in modern equipment
by investing in modern and sophisticated machines then it would be easy to improve output per worker.
- make it more efficient and produce more goods per hour, boosting productivity
- machinery/capital investment is expensive and may take years to recoup the costs so is a very long-term strategy to improve productivity
explain the factor affecting productivity of the ability level of those at work (training)
a skilled and well-trained workforce is likely to produce more and make fewer mistakes. employees should be able to complete tasks faster and will not need as much supervision or advice.
however training isn’t liked by all companies as there is great risk that once they are trained they leave for another business and so it will be costly or that the training will not provide the sufficient gains to justify the initial investment. there is also a loss in productivity whilst they are being trained.
explain the factor affecting productivity of improving employee motivation
Professor Herzberg believed that it was important to design jobs that contained motivators to help improve their productivity.
a motivated sales force may achieve many more sales than one that is unmotivated. overall business performance swill be boosted if they are motivated.
what are the difficulties of increasing productivity?
the role of management
- productivity has never been a central focus for directors, they are more focused on profits
- perhaps the key management role is to identify productivity as a main objective.
- it is harder by far to re-organise the workforce in order to make production more effective. managers whose main focus is on the short term will focus on production not on productivity
what is the link between productivity and competitiveness?
as productivity gets lower it causes higher costs per output which makes UK producers less competitive.
an increase in productivity means that they can become more competitive due to the fact they will producing more goods and so can compete by price.
the business will enjoy E.O.S and can therefore charge a competitive price.
they can gain a competitive advantage through lower prices. they can become market leader through lower prices or enjoy high profits due to lower production costs.
fortunately, competitiveness is not just about costs. it can be determined by the demand in a certain product. if the price elasticity goes down it means that people are more likely to buy more expensive products.
are efficiency and productivity the same?
No. productivity is output per worker per time period. this ignores other features of efficiency, notably waste. one fast worker may produce a lot of output but in a wasteful manner. a decorator may paint quickly but messily, wasting 20% of the point. so productivity may be high but overall efficiency no better than average. products emitting pollution are also not efficient.
what is the most efficient production level?
the level at which total unit costs are as low as possible.
