Theme 2 Flashcards
Owner’s capital (internal finance)
> an owners own personal savings, or even redundancy payment
> only relevant in a start-up or small business context
Retained profit (internal finance)
> once all costs have been covered and dividends paid to shareholders, any profit left is retained in the business and can be used as a source of finance.
> probably the safest and most common form of internal finance
> the business must have made a profit and not spent it on anything else. This is not possible for a new business start-up
Sales of assets (internal finance)
> especially available when businesses are changing strategy, is the cash generated from the sale of assets
> there may be assets that are no longer needed and thus can be sold to generate cash for other projects
> only for an established business
Family and friends (external finance)
> family and friends can provide extra start-up capital
> this may be taking an equity (shareholding) stake in a business set up as a limited company.
> family and friends may provide loans where banks may be unwilling
> almost certainly limited to small business contexts
Banks (external finance)
> loans to start-ups are not very common
> banks see start-ups as an extremely risky proposition
> where a loan is provided, banks will insist on some collateral as security, either. business asset or a personal asset belonging to an owner
> most widely applicable source of finance
Peer-to-peer funding (external finance)
> relies on websites that can match investors willing to lend to business start-ups with start-ups needing finance
> these loans will generally be at a fairly high rate of interest
> rare, most likely to be used for a particularly risky start-up
Business angels (external finance)
> these are extremely rich individuals who provide capital to high risk, small business ventures or start-ups
> willing to invest and become involved in the strategic management of the business in the hope of high returns
Crowdfunding (external finance)
> allows small investors to find business start-ups in which they are willing to invest through crowdfunding websites
> no single investor is likely to be big enough to provide all the finance needed for each business using the site
> the beauty of crowdfunding is that many small investors can be gathered in order to provide all the finance necessary
other business (external finance)
> some businesses, especially large firms, actively seek out small businesses either starting-up or in their early stages and help them out by providing finance
> in return, they will take a shareholding
> commonly, this practice occurs in technology-based industries
Loans (methods of finance)
> loans can be provided by banks, friends and family or directors of the business
> a loan involves providing a lump sum of cash, which will be repaid over an agreed period of time
> interest payments will also be made over the course of the loan
> interest rates can be variable or fixed, decided at the time the loan is taken out
Share capital (methods of finance)
> when a private company is formed, the ownership of the business is split into shares
> these shares can be sold, putting capital into the business
Venture capital (methods of finance)
> this is generally through a mix of loans and share capital
> as the investment is high risk, the loan is likely to be at a relatively high interest rate and the venture capitalist is likely to expect a relatively high shareholding
> generally used to a fund a significant period of growth for an established small business
Overdrafts (methods of finance)
> a facility offered by a bank to allow spending money even when the account becomes negative
> the interest rate is likely to be higher than that on a loan, but as long as the business stays out of their overdraft the cost is not great
> suitable for a short-term cash-flow problem
Leasing (methods of finance)
> avoids large chunks of cash outflows each time a major new asset is purchased
> although in the long term leasing will be more expensive than purchasing an asset outright
Trade credit (methods of finance)
> goods or services provided by a supplier are not paid for immediately
> start-ups or those with a poor record of payment in the past my be refused credit by suppliers
Grants (methods of finance)
> handouts, usually to small businesses, from local or central government
> the only start-ups that may receive a grant are those likely to create jobs in areas of economic deprivation, or hi-tech firms competing with foreign rivals
Business plan
a business plan is a document setting out a business idea and how it will be financed, marketed and put into practice.
preparation of the plan also :
> helps to ensure the entrepreneur has carefully considered potential problems
> has a reference point to maintain a clear sense of direction
> has some quantitive targets to aim for
Interpreting cash flow forecasts
> cash inflow shows the places and timings from which cash flows into the business
> cash outflow shows how much cash level the business has each month
> monthly balance, sometimes called net cash flow, shows the net effect for the month on cash flow (cash inflow - cash outflow)
> opening balance (usually at the top of the table) shows the amount of cash the business has at the beginning of the month. This will be last month’s closing balance
> closing balance shows the amount of cash in the business at the end of the month, calculated by adding the monthly balance (net cash flow) to the opening balance
Analysing cash flow forecast
> closing balance: if negative this shows the need for extra finance, quite possibly the need to arrange an overdraft so that the business can continue to spend after its bank balance has fallen to zero
> monthly balance (net cash flow): this will indicate how well each month is expected to go for the business
Uses of cash flow forecasts
> to spot cash problems in advance so that action can be taken in time to repent a major crisis.
examples of actions that can help to improve cash flow include:
> producing and distributing products as quickly as possible, reducing the time between paying for materials and receiving cash for finished goods
> chasing customers to pay quickly. This could involve more careful credit control, getting credit customers to pay on time
> keeping stocks to a minimum as stock represent cash sent, but not yet converted back as a cash inflow
> minimising spending on equipment, using leasing or renting as methods of finance, or even postponing investments
Limitations of cash flow forecasts
- the forecast is only as good as the estimations that have been made in order to generate the figures
- since most entrepreneurs tend to be fairly optimistic, there can be great danger that cash inflows are forecast too high, or too arrive predictably
- a table of figures can give the impression of factual data whereas, in reality, a cash flow forecast remains a best guess of what is likely to occur in the future
- if users of the cash flow forecast trust the accuracy of the document too much, they may be lulled into a false sense of security
Purpose of sales forecast
> HR plan : in order to ensure that the right number of staff with the right skills are employed
> marketing budgets : in order to decide how to allocate its marketing budget, whether to boost sales of a star or to try to revive the sales of a struggler
> profit forecasts and budgets: when planning how much the firm is expecting to make in revenue and profit, it helps to shape the expectations of spending as shown in budgets for different departments
> production planning : if the business is to satisfy demand for their product they will need to ensure that enough products are made.
Consumer trends (affecting sales forecasts)
effective sales forecasting must allow for the effect on demand of consumer trends changing
consumer trends may be based on :
> demographics : the UK has an ageing population, meaning increased demand for products aimed at the elderly
> globalisation : this is an increased willingness to buy products, from food to holidays, which recognise the global nature of today’s world
> affluence : despite short-term economic problems, over the past 70yrs, UK consumers have become wealthier, thus are more able and willing to spend on luxuries
> economic variables : economic fluctuation, such as a recession, can have a major impact on sales, especially of income elastic products.
economic variables (affecting sales forecasts)
in addition to changes in the economic cycle, changes in individual economic variables can affect sales :
> value of the pound : a decrease in the value of the pound makes imports more expensive and may push consumers to favour UK-produced products
> changes in taxation : taxes on individual items, such as alcohol, can affect demand, as well as changes in general taxation, such as the rate of VAT
> inflation : if inflation is higher than the rate of increase of average incomes, consumers will need to tighten their belts, spending less and damaging sales of some products and services
Actions of competitors (affecting sales forecasts)
> changing price : a competitor that begins to undercut your prices is likely, depending on price elasticity, to steal sales.
> launching new products : a competitor launching a new product, or a new competitor entering your market, can have a dramatic negative effect on forecasted sales, leaving precautions looking overly optimistic
> promotional campaign : competitors running successful promotional campaigns to try to steal market share from your product can leave sales forecasts looking overly optimistic
Sales revenue (calculation)
sales volume x selling price
Total costs (calculation)
fixed costs + variable costs
Fixed costs
these are costs that do not change as output changes. They are linked to time rather than to how busy the business is. Fixed costs have to be paid even when the businesses is not producing.
examples :
> rent
>interest charges
> business rates
> advertising spending
> management salaries
> heating and lighting
Variable costs
these are costs that change in direct proportion to the level of output.
examples :
> raw materials
> fuel costs
> piece-rate pay
> packaging
Total variable costs (calculations)
variable cost per unit x number of units produced (output)
Total costs
> a business with a high proportion of fixed costs is better off trying to boost sales volumes so that fixed costs are spread over more units of output
> for a business with relatively low fixed costs but higher variable costs, it is easier to operate at low levels of output, since their fixed outgoing each month will be relatively low
Profit (calculation)
sales revenue - total costs
Break-even point (calculation)
fixed costs / (selling price - variable costs per unit)
Break-even charts
> the fixed costs line is flat, showing that fixed costs are the same at all levels of output
> the total cost line shows the affect of adding fixed costs and variable costs together, therefore it start at the fixed costs line and moves upwards in line with the rate of increase of variable cost
> the total revenue line begins at point (0,0) since no revenue is generated if nothing is does
> the break-even output is identified by dropping a vertical kine down forth point at which total revenue and total costs dross to read off the amount of output that needs to be sold to cover costs.
Margin of safety
the horizontal distance between the actual output of a business and its break-even output is called the margin of safety.
this shows how far demand can fall before the firm slips into a loss-making position, and can be a vital figure to look out for during difficult trading periods.
limitation of break-even analysis
- variable costs are assumed to increase constantly
- break-even analysis assumes that the firm sells all its output in the same time period, which may well be untrue
- break-even analysis is based on a firm selling only one product at a single price
- any break-even chart is a static model, showing only the possible situation at one moment in time. it can’t show the effects of changing external variable such as consumer trends
Budgets
a budget is a target for revenue or costs for a future time period.
> income budget : this sets a target for the value of sales to be achieved
> expenditure budget : this gives budget-holders a limit under which they must keep their department’s costs
setting both an income and expenditure budget allows for a budgeted profit figure to be identified in each month.
Budget holders
- directors agree a ‘master budget’ for the whole firm and divide it between …
- regional managers who allocate a budget to each …
- branch manager who divides the branch budget between …
- section managers who will try to get all their …
- shopfloor workers to help meet the budget targets
Type of budget
> a historical budget : set using last year’s budget as a guide and then making adjustments based on known changes in the circumstances for the department
> zero-based budget - setting each budget to zero each year and then expecting each budget holder to justify a budget figure that they can work to for the common year.
(this is very time consuming but can avoid the wastage that may occur if all budgets creep upwards each year under a system of historical budgeting)
Variance analysis
involves looking back to calculate the difference between a budgeted figure and the actual figure that occurred
> adverse : the actual figure was worse than the budgeted
> favourable : the actual figure was better for the business than the budgeted figure
