Theme 2 Flashcards
Define internal finance
Internal finance comes from the owner’s capital, retained profit, or sale of assets
What is owner’s capital
Personal savings
Why might an owner use their personal savings?
If there is a short term cash flow problem
3 sources of internal finance
- Owner’s capital (Personal savings)
- Retained profit
- Sale of assets
Define retained profit
Retained profit is the profit that has been generated in previous years which has been not distributed to owners and is reinvested back into the business
Benefit of retained profit
Retained profit is a cheap source of finance, as it doesn’t involve borrowing and interest payments
Drawback of retained profit
There is an opportunity cost that shareholders do not receive as much dividends
Define sale of assets
Sale of assets includes selling business assets which are no longer required
What is a sale and leaseback arrangement
- When a business wants to continue to use an asset but needs cash.
- rents the premises from new owners
4 benefits of internal finance
- Often free
- Maintain control over business
- Can get quickly without bureaucracy
- No need for background checks that are needed for loans
3 drawbacks of internal finance
- Profit is not available for other uses (opportunity cost)
- May not be sufficient
- Not as tax-effiecent as loans as loan are classed as a business cost and no tax is paid on them
Define unlimited liability
Unlimited liability is when owners are fully responsible for all debts owed by the business
Define limited liability
Limited liability is when owners are not responsible for business debts as they are considered a separate legal entity to the business
Define cash flow forecast
A cash flow forecast is a prediction of the cash inflows and cash outflows usually for a six to twelve month period
Define net cash flow
Net cash flow is calculated by subtracting the total outflows from total inflows
Define opening balance
The opening balance is the previous month’s closing balance carried forward
Define closing balance
The closing balance is calculated by adding the net cash flow to the opening balance
2 benefits of using cash flow forecasts
- Can support an application for a loan
- Can help identify when finance is needed like an overdraft
2 drawbacks of using cash flow forecasts
- Forecasts are based on estimates and reality may differ
- External factors can impact cashflows and this may not be accounted for in the forecast
Define sales forecasts
Sales forecasts predict future revenues based on past sales figures
What 3 factors affect sales forecasts?
- Consumer trends
- Economic variables
- Actions of competitors
3 difficulties of sales forecasting
- External factors
- Bias to the past
- Complexity of data selection
Define sales volume
Sales volume is the number of units sold by a business
Define sales revenue
Sales revenue is the value of units sold by a business
Define Fixed Costs (FC)
Fixed costs are costs which don’t change as the level of output changes.
Define Variable Costs (VC)
Variable costs are costs which vary with output
Define Total costs (TC)
Total costs are the sum of the fixed and variable costs
How to calculate total costs?
Total fixed costs + Total variable costs
How to calculate total variable cost?
Variable costs x QTY
How to calculate average total cost?
Total cost / QTY
How to calculate variable cost per unit? (AVC)
Total variable costs / QTY
What does average total cost represent?
ATC represents cost per unit
How to calculate contribution
Contribution = Selling price per unit - variable cost per unit
Define break-even point
The break-even point is where the total revenue is equal to total costs
How to calculate the break-even point
Break even point (Units) = (Fixed costs / Contribution)
Define Margin of safety
The margin of safety is the difference between the actual level of output and its break even level of output
How to calculate margin of safety
Margin of safety = Actual level of output - Break even level of output
2 Limitations of break even analysis
- Less useful for businesses which produce more than one product
- Have to be remade when costs and prices change
Benefit of break even analysis
Can be used to gain external finance
Define budget
A budget is a financial plan that a business sets about costs and revenue, which are usually set annually
4 reasons for using a budget
- To plan ahead and solve problems in advance
- Help managers control their resources and help achieve their objectives
- Helps coordination within the business
- Spreads decision making throughout the business, motivating managers who control the budgets
2 methods of budgeting
- Historical data budgets
- Zero-based budgeting
Define historical data budgets
Historical data budgets are based on historical data and allow for factors like inflation and exchange rate changes
Define zero-based budgeting
Zero based budgeting is when all spending needs to be justified from scratch for each period, with nothing based on previous budgets
2 limitations of zero-based budgets
- Can be time-consuming as evidence to support spending decisions need to be collected
- Requires skilled employees to convince those who make purchasing decisions
What is a budget variance?
A budget variance is a difference between a figure budgeted and the actual figure achieved by the end of the budgetary period
What is variance analysis
Variance analysis aims to determine the reasons for the differences in the actual figures and budgeted figures
What is a favourable variance?
A favourable variance is where the actual figure achieved is better than the budgeted figure
What is an adverse variance?
An adverse variance is where the actual figure achieved is worse than the budgeted figure
How to calculate variance analysis?
Variance = Budgeted - actual
3 Difficulties of budgeting
- Data must be up-to-date, accurate and free of bias. This may mean training or specialist staff is needed
- Unrealistic budgets can lead to a lack of motivation
- Conflict between budget holders, reducing productivity
Define gross profit
Gross profit is the difference between revenue and costs of sales
How to calculate gross profit?
GP = Revenue - cost of sales
Define operating profit
Operating profit is the difference between the gross profit and operating expenses
How to calculate operating profit
OP = Gross profit - operating expenses
Define Net profit
Net profit is the difference between the operating profit and interest payments or one off costs
How to calculate net profit
NP = Operating profit - (Net interest + Exceptoinal costs)
Define statement of comprehensive income
The statement of comprehensive income is an end of year financial statement that shows all of a businesses income and expenses over the previous year
Define profit margin
A profit margin is the amount by which the sales revenue exceeds the costs
How to calculate gross profit?
(Gross profit / revenue) x 100
4 ways to improve profitability
- Raising prices
- Reducing variable costs
- Reducing staffing costs
- Reducing one-off costs and interest charges
How would a business reduce its variable costs?
Find cheaper suppliers or purchase in bulk
What are the impact on staff morale if the business reduces staffing costs?
Reduced staff morale and reduced productivity
What does reducing one-off costs and interest charges include?
Lease instead of buying capital
Define cash
Cash in measured by taking into account the range of money flowing into and out of a business
What may cash-poor businesses struggle to do?
May struggle to pay suppliers
What does the statement of financial position have information to draw conclusions about?
The STOFP has the financial information required to draw conclusions about the liquidity of a business
Define liquidity
Liquidity is the ability of a business to meet its short term commitments with its available assets
Why is managing liquidity important?
To manage risk and help prepare for the unexpected
Define assets
An asset is a resource owned by a business used to generate output
Define liability
Liability is a debt that has to be repaid
Define non-current asset
A non-current asset are assets which are owned by a business for the long-term
Define current asset
A current asset are assets that are converted into cash quickly, usually within 1 year
Define current liability
A current liability is money a business owes and needs to be repaid within 1 year
Define non-current liability
A non-current liability is money a business owes and that does not need to be paid pack for at least 12 months
How to calculate net assets?
NA = Assets - Liabilities
What does capital employed represent?
The total funding of assets
What is capital employed equal to?
Capital employed = Net assets
What 2 ratios can be used to measure the liquidity of a business
- Current ratio
- Acid test ratio
Define current ratio
The current ratio is a quick way to measure liquidity and the outcome is expressed as a ratio
What businesses is the current ratio best for?
Businesses which hold little stock
What does the current ratio represent?
The result indicates how many £’s of current assets it has available to cover each £ of short term debt
How to calculate current ratio?
Current assets / current liabilities
= ?:1
Define acid test ratio
The acid test ratio is a precise measure of liquidity as it excludes inventory, which is the least liquid form of current assets
How to calculate acid test ratio?
(current assets - inventory) / current liabilities
= ? : 1
5 methods to improve liquidity
- Reduce the credit period offered to customers
- Ask suppliers for an extended repayment period
- Use overdrafts
- Sell of excess stock
- Sell assets and lease them instead
What impact does reducing the credit period offered to customers have on liquidity
This will increase the level of current assets in the business, however, customers may move to competitors who offer better credit terms
What impact does the sale of assets and leasing them instead have on liquidity?
Increase in both current assets and current liabilities
Define working capital
Working capital is the money that a business has to fund its day to day activities
What else is working capital referred to as?
Net current assets
How to calculate working capital
WC = Current assets - current liabilities
Why is working capital important?
A lack of working capital can lead to business failure as the business cannot meet its immediate financial obligations
Why is cash the most liquid current asset?
Cash is the most liquid current asset because it can be used to settle debts immediately
What is the opportunity cost of having too much cash?
The opportunity cost is missing out on the benefits of investing the money
What is a drawback of a business holding large amounts of stock?
Higher storage costs
5 internal reasons why businesses fail
- Poor planning
- Lack of leadership
- Ineffective marketing
- Cash flow problems
- Lack of funds
What does lack of leadership which leads to business failure include?
Leaders may lack the skills or experience to run a business, especially in times of crisis
What does cash flow problems which leads to business failure include?
Business becomes difficult to operate on a day to day basis
5 external causes of business failure
- Economic challenges
- Changes in consumer tastes
- Legal factors
- New competition
- Technological change
As an external cause of business failure, what does legal factors include?
A change in legislation may mean that products or processes may need changing
How does economic challenges lead to external business failure?
Business that rely on borrowing or sell normal goods may not survive recessions, due to the lack of consumer income and high interest rates
How does new competition lead to external business failure?
Businesses may need to cut prices or spend more on promotion to maintain market share.
Define production
Production is the transformation of resources into finished goods or services
Define goods
Goods are physical products
Define services
Services are non-physical items
List the 4 methods of production
- Job production
- Batch production
- Flow production
- Cell production
Define job production
Job production is when a business produces one item at a time, as ordered by the customer
3 benefits of job production
- Higher quality
- Highly skilled workers
- Customised products
2 drawbacks of job production
- Slow production
- High labour costs
Define batch production
Batch production is when groups of the same product are produced
2 benefits of batch production
- Workers can specialise
- Can produce next batch as soon as previous batch starts to run out
2 drawbacks of batch production
- Requires careful coordination to avoid shortages
- Completed products need to be stored
Define flow production
Flow production is the continuous manufacturing of standardised products on the production line
3 benefits of flow production
- Low unit costs due to economies of scale
- Faster production
- Highly automated
2 drawbacks of flow production
- Lack of customisation
- Capital is expensive to buy
Define Cell production
Cell production involves workers being organised into multi-skilled teams, with each team being responsible for one part of the production process
2 benefits of cell production
- Specialisation
- High motivation as workers work in a team
1 drawback of cell production
- Team efficiency may be reduced by weaker workers
Define labour productivity
Labour productivity is a measure of the output per worker in a period of time
How to calculate labour productivity
Output / Number of workers
Define capital productivity
Capital productivity is a measure of the output of capital employed during a period of time
How to calculate capital productivity
Output / Number of machines
What 2 things can a business do when it has lower cost per unit?
- Lower prices
- Enjoy increased profit margins
What 4 things influence productivity?
- Employee motivation
- Skills and training
- Level of flexible workforce
- Investment in capital goods
Define competitiveness
Competitiveness refers to the ability of a business to maintain or grow its market share given the presence of rivals
What is the link between productivity and competitiveness?
Businesses that are competitive are likely to have the financial resources to invest into improvements in their productivity
Define efficiency
Efficiency is the ability of a business to use its production resources as cost-effectively as possible
What is efficiency also reffered to as?
Average cost per unit
How to calculate average cost per unit (Efficiency)
ACPU = Total costs / Number of untis
When does maximum efficiency occur?
Maximum efficiency occurs at the point where the costs are at their lowest
6 factors which influence efficiency
- Standardisation of the production process
- Downsizing
- Investment in capital equipment
- Reducing staff and delayering
- Outsourcing
- Lean production techniques
What is outsourcing?
When tasks may be given to other specialist businesses that can complete it at a lower cost
Define labour intensive production
Labour intensive production uses physical labour in the production of goods/services
Define Capital intensive production
Capital intensive production uses machinery in the production of goods and services
3 benefits of capital intensive production
- Low cost production
- Consistent with high quality
- Can operate without breaks
3 drawbacks of capital intensive production
- High set-up and maintenance costs
- Breakdowns can delay production
- No flexibility in production
3 benefits of labour intensive production
- Low cost production where labour costs are low
- Workers can be creative
- Workers are flexible
3 drawbacks of labour intensive production
- Workers may be unreliable and need breaks
- Incentives needed to motivate staff
- High training costs
Define capacity utilisation
Capacity utilisation compares current output to maximum possible output a business can produce using all assets
How to calculate capacity utilisation
CU % =
(Current output / Max possible output) x 100
3 Implications of capacity under-utilisation
- Higher unit costs as fixed costs are spread over fewer units
- Workers may be underemployed
- Flexibility to respond to an increase in demand
3 drawbacks of capacity over-utilisation
- Lack of flexibility to respond to an increase in demand
- Staff turnover
- Breakdowns in capital
2 benefits of capacity over-utilisation
- Busy workers feel job security
- Minimise average total costs
3 ways to increase capacity utilisation
- Increase demand
- Reduce capacity by selling capital or reducing staff
- Outsourcing
Define stock control diagram
A stock control diagram shows the flow of stock into and out of a business over time
What is the maximum stock level on the stock control diagram?
The maximum amount of stock a business is able to hold in normal circumstances
What is the reorder level on the stock control diagram?
The level at which a business places a new order with its supplier
What is the minimum stock level on the stock control diagram?
The minimum stock level is also known as the buffer stock level and is the lowest level the business is willing to allow stock levels to fall
What is the lead time on the stock control diagram?
The lead time is the length of time from the point of stock being ordered from the supplier to it being delivered
Define buffer stock
The buffer stock is a quantity of stock kept in case of shortages
Why do businesses keep buffer stock?
Can provide competitive advantage over rivals who are unable to meet demand
Benefit of buffer stock
Can give business a good reputation of being able to meet the needs of its customers
3 drawbacks of buffer stock
- Storage costs
- Can become obsolete if demand declines
- Opportunity cost as capital can be spent on other areas of the business
2 implications of holding too much stock
- High storage costs
- Goods could be perishable
2 implications of holding too little stock
- May run out of stock
- Sudden increase in demand may not be able to be met
Define Just in Time (JIT) stock management
Just in time stock management is a process where stock is ordered and delivered exactly when needed
2 benefits of JIT stock management
- Reduced storage costs
- Improved cash flow
3 drawbacks of JIT stock management
- Purchasing economies of scale not possible
- Less flexible to increases in demand
- Poor suppliers can delay production
3 ways to minimise waste
- Improved storage
- Staff training
- Effective sales forecasting
Define lean production
Lean production is the minimisation of the resources used in production
2 benefits of lean production
- Reduced storage needed due to JIT Stock control.
- Lower unit costs due to minimal wastage
Define quality
Quality is the features of a product that satisfy customer needs
List the 4 methods of quality management
- Quality control
- Quality assurance
- Quality circles
- Total quality management (TQM)
What is quality control?
Quality control is inspecting the quality of output at the end of the production process
2 benefits of quality control
- Standards are maintained
- Inexpensive
2 drawbacks of quality control
- Waste of resources as goods need to be removed
- Cause of defects still unknown
Define quality assurance
Inspecting the quality of production throughout the production process
2 benefits of quality assurance
- Products can be reworked instead of rejected
- Cause of defects can be found, reducing future issues
2 drawbacks to quality assurance
- Staff training needed
- Reworking may lengthen the production process
Define quality circles
Quality circles are groups of workers who meet regularly to solve quality problems found in the production process
2 benefits of quality circles
- Motivated workers as they are involved in decision making
- Relevant solutions are likely as workers are familiar with processes
1 drawback of quality circles
- Meetings must be organised regularly
Define Total quality management
Total quality management is when the business has quality at its core and every worker is responsible for quality
2 benefits of TQM (Total quality management)
- Improved efficiency
- A culture of constant improvement
2 drawbacks of TQM (Total quality management)
- All workers need training
- Monitoring is needed
What is Kaizen
Kaizen is when a business takes continuous steps to improve productivity by making small and ongoing steps
What management does kaizen need?
A long-term management commitment
What is the competitive advantage gained from quality management? (3)
- Lower unit costs
- Increased finance available
- Improved brand reputation
Define inflation
Inflation is the general rise in prices in an economy over time
4 impacts of inflation
- Increased costs
- Higher loan repayments
- Less demand
- Loss of international competitiveness
Define exchange rate
The exchange rate is the value of one currency expressed in terms of another
Define interest rate
The interest rate is the reward for saving and the cost of borrowing
Define the business cycle
The business cycle describes the upturns and downturns in the level of a country’s gdp over time
What is an economic boom?
A boom is a period of time where an economy expierences high rates of economic growth
3 Impacts of a recession on businesses
- Less demand
- Easier recruitment
- Reduced production levels
When does economic uncertainty occur
Economic uncertainty occurs when it is difficult to forecast the level of supply and demand in an economy
3 reasons economic uncertainty may occur
- Changing exchange rates
- Economic growth uncertainty
- Price rise in commodities
2 ways businesses can prepare for economic uncertainty
- Building up cash reserves in economic booms
- Keeping informed of the economic climate
Define legislation
Legislation is the laws and regulations passed by governments
5 areas of legislation:
- Consumer protection
- Employee protection
- Environmental protection
- Competition policy
- Health and safety
Define consumer protection legislation
Consumer protection means that consumers are treated fairly in the areas of safety, standard of quality, and no false claims
Define employee protection
Employee legislation aims to prevent the exploitation of workers in the areas of pay, working conditions, equality, and trade unions
4 impacts of employee protection on businesses
- Penalties if laws are broken
- Higher labour costs
- More training needed
- Motivated staff if laws are met
Define environmental protection laws
Environmental legislation aims to hold businesses responsible for their environmental impact
Impact on businesses of environmental protection laws
Businesses may be fined or forced to stop all activity until they meet the regulations
Define competition policy
Competition policy aims to protect the interests of both consumers and businesses by stopping anti-competitive practices
Define health and safety legislation
Health and safety legislation requires businesses to operate in a way that protects the physical and mental wellbeing of its workers and customers
3 areas of health and safety regulation
- Provision of breaks
- Provision of safety equipment
- Hygienic working conditions
Define competition
Competition refers to the rivalry between firms in the same industry who aim to increase their market share
Define market size
Market size the number of customers and sellers in a market
