Theme 2 Flashcards
Why do firms need money
To purchase equipment,raw materials,obtain premises and hire workers
2 categories of expenditure
Capital Expenditure
Revenue Expenditure
Capital Expenditure
Is the spending on items that may be used over and over again eg company vehicle,machinery,new factory
Revenue Expenditure
Refers to payments for goods and services that have either been consumed or will be used up soon eg raw materials and fuel
Capital
refers to money used to run a business
Internal Finance
Is money generated by the business or current owners
Retained Profits
Are profits generated by a business and put aside by the owners and saved for later in case of an emergency
Why are retained profits the cheapest source of finance
Because it is not charged interest and administration cost
Consequences of retained profits on small businesses
It means owners and their families may have less money to fund their lifestyle
Consequences of retained profits on larger companies
It means shareholders of the company will receive less dividend payments
Why are retained profits flexible
They do not need to be used immediately and can be accumulated and placed in a bank where it will gain interest
Advantages of internal finance
The capital is available immediately
Internal finance is cheap as there are no interest payments
Disadvantages of internal finance
Can be limited and may end up having to sell unwanted assets
There are no inflationary benefits
Factors of Production
Land
Labour
Capital
Enterprise
Owner’s Capital
Capital is the money provided by the owners in a business
The Methods of Internal Finance
Owner’s Capital
Retained Profits
Sales Of Assets
What might a business have to do if it is struggling to pay costs
May downsize/retrench. This means that the business makes its premises smaller to be more affordable
External Sources of Finance
Family and friends
Banks
Peer to peer lending
Business angels
Crowd-Funding
Family and friends
Used mainly by small businesses which consists of coming into agreement with mutual relations regarding a sum of money which you will pay back usually with little to no interest.
Banks
Commercial banks such as Barclays,NatWest and Metro. They offer a range of finance sources for businesses such as loans,overdrafts and mortgages
Peer to Peer lending
Involves people who have no relation lending lending another person a sum of money to avoid using a bank
What happens in peer to peer lending
.All loans are unsecured means there is no protection for lenders
.All transactions are placed online
.No previous relation between lenders is required
Business Angels
Are individuals who typically invest between £10k-£100k in exchange for a stake in the business
Reasons business angels invest
Some angels do this for the rush of risk,may be attracted by tax relief or saw an opportunity in investment for unused income.
Crowd Funding
This is a type of fundraiser where businesses or groups give a business. These people are usually involved in a particular centre such as staging the production,building a school or setting up a community project. Transactions are conducted online
Methods of finance
Internal
External
Loans
Is the process by which a business borrows a sum of money from a bank which has to be repayed with interest
Advantages of loans
Banks will not ask for a % of the business or get involved in the running of the business
Getting into a high street bank to apply for a business loan is a straightforward process
Disadvantages of loans
A bank will charge interest on the loan
Not very flexible, the business may incur a penalty if they decide to settle the loan early
A bank will ask for security or collateral on a loan this may be a house or another asset that can be seized if the loan is not paid back
Share Capital
Raising finance by issuing shares of the company in the stock market
Advantages of share capital
Investors are often prepared to provide extra funding as the business grows
More cost effective way to raise finance than a loan – no interest to pay back
Disadvatanges of share capital
The more shares that are sold, the more the profits have to be divided up and paid out to investors as dividends
Can be expensive and slow process to organise
Venture Capital
individuals which invest large sums of money into people’s business in return for shares in the company
Advantages of venture capital
The business gets all the skills of the venture capital business, their network and links may increase revenue streams
Great for owners who have been refused a loan from a bank
Disadvantages of venture capital
Venture capital firms look for a strong business plan, sound management and a proven track record, making it difficult for start-up firms
Venture capital firms typically want 20-30% stake in the business
Overdrafts
allows a business to go over the amount they have in the bank. Has to be repayed later on
Advantages of overdrafts
For a business owner this would idea as a quick fix method to tide the business over a difficult month of trading
Can be quick to arrange by phone or online with an instant decision
Disadvantages of overdrafts
If the business goes over this amount the overdraft will be “unauthorised” and the business will be charged heavily
Very expensive source of finance, very high charges and interest rates
Leasing
Is the process by which allows a business to spread costs of something over a period of time to make it easier to pay back. However the business will never own the asset.
Advantages of leasing
This is a lower monthly costs for a business owner than a loan
The leasing firm maintain the equipment, vans, cars etc. so the business will always have reliable working equipment
Disadvantages of leasing
Leasing is often over a fixed term, if the business changes its mind and wants to lease from a different company, contracts may be difficult to get out of
Trade credit
Where the seller gives a business a longer period of time to pay in installments rather than all in one go
Advantages of trade credit
No interest has to be paid on trade credit
Businesses that pay regularly on time can build relationships with their suppliers and secure better deals
Disadvantages of trade credit
Not all stock is available to buy using the trade credit method, so only applies to certain industries
If the business does not pay in time they risk being refused further credit by the supplier in the future
Grants
Where the UK pays businesses to set up in certain areas to help the spread of economy. These do not need to be repaid
Advantages of grants
The business usually will not have to pay the grant back
Unlike a loan there will be no interest to pay
The business owner will get funds without any loss of control of the business
Disadvantages of grants
A business will have to find a grant that suits their specific project, which can be difficult
There’s a lot of competition for grants
Limited Liability
The owner has a separate legal identity from their business
Unlimited Liability
The owner and business are legally bound. They are responsible for any torubles the business falls into
Which 2 business formats have unlimited liability
Sole Traders and Partnerships
Implications of unlimited liability
If a business gets into financial trouble or is sued a sole trader or partnership businesses may have to sell their own assets (like a family car) to pay the debts of the business
The business and the owner are seen as one legal entity, so are equally liable (responsible) for the debts
Which 2 business formats have limited liability
Private Limited Company (ltd)
Public Limited Comoany (Plc)
Implications of limited liability
The owner and the business have separate legal identities so can sue or be sued separately
The owner and the business can own separate assets
The business can now sell parts of the business called shares to shareholders
Suitable methods of finance for an unlimited liability business
Business loans from a bank
Private investors e.g. angels
Credit cards from a bank
Crowd funding from websites
Trade credit from suppliers
Suitable methods of finance for limited liability business
Retained profit from the business
Sale of assets from the business
Ordinary and preference share issues
Government grants
Venture capital – as they may be borrowing larger amounts than unlimited liability businesses
Business Plan
A document which sets out the future plans for a business
Why does a business write a business plan
To give the owners some direction – once a plan is written down it is more likely to be followed
To set targets (smart) and objectives that can be followed
Whats included on a business plan
Cash Flow Forecast
Name of the business
Product or service and the market it is aimed at
4 Ps of marketing; product, price, place and promotion
Human resources; who will be working there, managers, owners etc.
Production costs and potential suppliers of materials
Premises and how it will be financed; rent, mortgage, bought outright, leased from council
Financial information; projections on revenue, costs and profits
Purpose of a business plan
To help set up a new business
To help the business raise finance
To help the business to set objectives
To outline how functions of the business will be organised
What is a cash flow forecast
A cash flow forecast is the day-to-day running of a business budget
What does a cash flow forecast show
A cash flow forecast will show where the business will have a shortfall of cash
Cash inflow (income)
Appears at the top of the document. Most likely to be the sales revenue
Cash outflow (expenditure)
Is the cash that is being spent. This will be on bills such as wages,insurance,advertising etc
Opening and closing balance
The amount of cash a business has at the start and end of each month
Uses of cash flow forecast
To help monitor the cash coming in and out of a business
A good cash flow will help a business secure a better deal on their finance
Limitations of cash flow forecasts
It is merely an estimate
Owner may have overstated or understated income and other factors
Sales forecast
A sales forecast estimates the volume or value of future sales using market research or past sales data.
Purpose of sales forecast
Avoid cash flow problems
Frees up managment time
Production capacity
Employ more workers
Factors affecting sales forecast
Consumer Trends
Economic Variables (inflation,unemployment,GDP)
Actions of competitors
Difficulties of sales forecast
No guarantees
Dynamic markets
Sales Volume Formula
SV=Sales Revenue/Selling Price
Sales Revenue Formula
SR=Selling Price x Sales Volume
Fixed Costs
Costs that do not change with the level of output
Examples of fixed costs
Rent
Mortgage
Loan
Insurance
Leasing
Variable Costs
Costs that vary with the level of output
Examples of variable costs
Cost of stock
Raw Materials
Fuel
Wages
Total Variable Cost Formula
TVC=Average Variable Cost x Quantity
Total Costs Formula
TC=Variable Cost + Fixed Costs
Break Even
Is the point where a business makes neither a profit nor a loss
Contribution
Is the amount that each unit produced contributes towards the fixed costs
Contribution Formula
C=Selling Price - Variable Cost per item
Break Even Formula
FC/Contribution
How to draw a break even chart
Draw Axis
Plot Fixed Costs
Plot Total Costs
Plot Total Revenue Line
Plot the B/E point
Margin Of Safety
Shows the number of sales that could be lost before a business makes a loss
Margin Of Safety Formula
Actual Sales - B/E level of sales
Uses of Break Even
To write a business plan
To calculate when they wil make a loss
Limitations of break even
Assumes everything made is sold
Does not take into account discounts
Budget
Is an estimate of income or expenditure for a set period of time
Purpose of Budgets
Planning
Forecasting
Communication
Motivation
Types of Budget
Historical Budget
Zero Based Budget
Historical Budget
Uses previous years of the businesses statements to calculate budget
Zero Based Budget
Based on potential performance such as the number of customers they anticipate to serve
Favourable Variance
where actual income is more than budget, or actual expenditure is less than budget
Adverse Variance
where actual income is less than budget, or actual expenditure is more than budget
Difficulties of budgeting
Time consuming to prepare, monitor and control
Unrealistic budgets can be demotivating
Limitations of budgeting
Budgets can cause inter- department rivalry as some departments get more money than others
Can make managers short-term and short-sighted, they become budget driven rather than customer driven
Profit
The sum of money left after all costs are paid
Statement of comprehensive income
a historical record of the trading of a business over a specific period
Gross Profit Formula
Revenue - Cost of Sales
Operating Profit Formula
Gross Profit - Operating Costs
Net Profit Formula
Total Revenue - Total Costs
Gross Profit Margin Formula
Gross Profit Margin = (Revenue – COGS) / Revenue x 100
Operating Profit Margin Formula
OPM= Operaring Profit / Revenue x 100
Net Profit Margin Formula
NPM= Net profit / sales x 100
Ways to improve profitability
Increase Revenue
Reduced Costs
What is the difference between profit and cash
Profit is the sum of money remaning after all costs are paid however cash is the liquid asset used to keep the business afloat
Liquidity
The ability of a business to turn its assets into cash
Statement of financial position
the firm’s assets, liabilities and owners’ equity (net worth)
Measuring Liquidity
Current Ratio
Acid Ratio
Current Ratio Formula
Current Assets / Current Liabilities
Acid Ratio Test Formula
Current Assets - Inventory / Current Liabilities
Ways that liquidity can be improved
A business could reduce the amount of stocks that it holds
A business could reduce the credit period offered to customers
Working Capital
The day to day finance needed in a business
Working Capital Formula
Current Assets - Current Liabilities
Business Failure
when a business ceases to trade or when a business does not trade in a profitable way or when a business makes a terrible decision
Internal courses of business failure
Poor efficiency
Poor marketing
Failure to innovate
Bad management of working capital
Poor efficiency
When a business is unable to use all of its facilities and assets in a profitable and productive manner
Poor marketing
When a business fails to reach and please the target audience through inappropriate marketing startegiesn
Failure to innovate
When a business fails to move forward with time and adapt to developments in technology
Poor management of working capital
When a business puts money into the wrong places which do no develop a business’ efficiency, productivity and profitability
External causes of business failure
Economic Recession
Strong Pound- reduced export demand
Economic recession
A time period where customers will save rather than buy due to the increase cost of living. Customers will spend money on necessities and alternatives rather than luxury and normal goods
Productivity
Measures the relationship between inputs into the production process and the resultant outputs
Production
The process of making or manufacturing goods and products from raw materials
Methods of production
Job Production
Batch Production
Flow Production
Cell Production
Job production
Where the products are made one at a time tailored to the demands of the client or customers. Products made are of a high quality and premium prices can be charged
Pros of Job production
Quality is high because workers are skilled
Easy to organise
Custom made
Cons of Job production
High labour costs
Production may be slow
Batch production
Where a specific quantity of a product is made at a time eg Doughnuts, Sofas, Armchairs
Pros of batch production
Workers are likely to specialise in one process
Production is flexible
Cons of batch production
More complex machinery needed
Requires planning and co-ordination
Flow production
Involves a continuous movement of items through the production process
Pros of flow production
Low unit cost due to economies of scale
Output can be produced very quickly
Cons of flow production
Products may be too standardised
Huge setup cost
Cell production
A form of team working and helps ensure worker commitment
Pros of cell production
Closeness of cell members should improve communication
Avoiding confusion arising from miscommunication
Ways to improve productivity
Productivity Bonus
Productivity Deal
Staff Training
Investment in new machinery and equipment
Productivity Bonus
Extra money workers reactive if they produce more of something than usual
Productivity Deal
An agreement where the employees of an organisation agree to improve productivity in return for an increase in pay or benefits
Staff Training
Is a programme which teaches employees the etiquette and methods of a job to improve their productivity
Investment in new machinery and equipment
Where a business chooses to put money into newer technology which produces at a faster rate increasing productivity
Factors influencing efficiency
Lean Production
Kaizen
JIT
Lean Production
An approach to operations that focuses on reducing the amount of resource needed
Kaizen
An approach to creating continuous improvement based on the idea that small, ongoing positive changes can reap significant improvements
Just In Time
Where products go straight from manufacture to customer to reduce storage space
Labour Intensive
Productions methods that make more use of labour
Pros of labour intensive
More flexible
Cheaper for small scale production
People more creative than machine
Cons of labour intensive
People are unreliable
People cannot work without breaks and holidays
People need to be motivated
Capital Intensive
Production methods that make more use of machinery relative to labour
Pros of capital intensive
Machinery can operate 24/7
Machinery is precise and consistent
Cons of capital intensive
Huge setup costs
Large delays if machinery breaks down
