theme 2 (in papers 2 & 3) Flashcards
managing business activity
what are some internal sources of finance?
- owners capital
- retained profit
- sale of assets
What are the benefits to using internal sources of finance?
- Internal finance is often free (e.g. it does not involve the payment of interest or charges)
- It does not involve third parties who may want to influence business decisions
- Internal finance can usually be organised very quickly and without significant paperwork
- Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily
what are the drawbacks of using an internal source of finance?
- opportunity cost, once retained profit has been used, it is not available for other purposes
- may not be sufficient to meet the needs of the business
what are some external sources of finance?
- loans
- share capital
- venture capital
- overdrafts
- leasing
- trade credit
- grants
what is limited liability?
- Limited liability means that the business owner or owners are only responsible for business debts up to the value of their financial investment in the business.
- This means that a creditor can only take assets or finances belonging to the company.
what is unlimited liability?
- is when an owners personal assets are at risk.
- This means that if the business were to fail and go bankrupt, the owner’s personal assets would be sold in order to try and recover the debt.
what are the implications of unlimited liability?
- There is no legal distinction between owners with unlimited liability and the business
- As a result, these business owners may have to use their own personal assets to pay debts or legal fees
- E.g. a sole proprietor may need to sell their home to pay creditors if their business fails.
what are the implications of limited liability?
- Companies are incorporated and owners are considered a separate legal entity to the business.
- This means that if a company fails, the owners would lose their investment but would not have to use their assets to meet additional debts or legal fees.
what does a business plan do?
- helps finance providers assess te business model.
- provides structure assesment of the opportunities and risks.
- encourages analysis of the competitive position of the business and the market.
- helps determine the amount of finance required.
why is cash flow forecasting important?
- cash flow problems are why most businesses fail.
- cash is king, its the lifeblood of a business.
- cash is limited so it needs to be managed carefully.
what are the benefits of cash flow forecasting?
- advanced warning of cash shortages.
- makes sure that the business can afford to pay suppliers and employees.
- spot problems with customer payments.
- provide reassurance to investors and lenders that the business is being managed properly.
how do you work out net cash flow?
cash inflow - cash outflow
how do you work out closing and opening balance?
opening = amount business starts with each month.
closing = opening balance + net cash flow
- a negative closing balance suggests business needs bank overdraft or additional financing.
define cash flow forecast.
- an analysis of estimated cash inflows and cash outflows over a future period and the resulting impact on cash balance.
what are the limitations of a cash flow forecast?
- theres some uncertainty.
- sales could prove lower than expected.
- customers pay not pay on time.
- costs pay proof higher than expected.
what does sales forecasting help with?
- human resource plan
- production / capacity plans
- cash flow forecasts
- profit forecasts and budgets
- a very useful part of competitve analysis and helps to focus market research.
what are the key factors that affect sales forecasts?
- consumer trends
. demand in markets change as consumer tastes do. - economic variables
. intrest rates, GDP, tax, exchange rates - competitor actions
when is sales likely to be inaccurate?
- business is new
- market subject to significant distruption from tech change.
- demand is highly sensitive to changes in price and income (elasity)
- product is a fashion item.
- significant changes in market share
- business has demonstrated poor forecasting abilities in the past.
how do you calculate sales revenue?
selling price x no. of units sold
how do you work out average total costs?
total costs
–.————–
quantity
what is economies of scale?
occurs when production rises at a rate faster than costs, with costs then being spread over a larger amount of goods.
what is diseconomies of scale?
occurs when a business grows so large that the costs per unit increase.
how do you calculate contribution?
selling price - variable costs
what is contribution?
the amount contributes towards paying off the fixed costs of the business.
Once the fixed costs have been paid off, then the contribution starts to contribute to the profits of the business.
define break-even.
The Point where a total revenue earned for a product is exactly equal to its total costs and where the business is making neither a profit nor a loss.
how do you calculate the break-even point using contribution?
fixed costs / contribution
what is the margin of saftey?
the difference between the actual level of output of a business and its break even level of output.
how do you calculate the margin of saftey?
actual level of output - break-even level of output
what are the limitations of break-even analysis?
- less useful if the business sells more than 1 product.
- the accuracy depends on the quality of the data.
- it assumes all output is sold.
what is a budget?
- A financial plan that a business sets about costs and revenue.
- The budget is usually closely aligned with the business objective.
why do business’ have budgets?
- planning and monitorting
- control
- coordination and communication
- motivation and efficiency
what ae the different types of budgets?
- historical budgeting
- zero budgeting
what is historical budgeting?
- uses last years figures as the basis of the budgets.
- realistic in that its based on actual results.
- however circumstances might have changed i.e. new products, lost customers.
- doesnt encourage efficiency.
what is zero budgeting?
- budgeted costs and revenue are set to 0.
- its based on new proposals for sales and costs.
- makes budgeting more complicated and time consuming, but potentiallymore realistic.
what is variance analysis?
- the difference between a figure budgeted and the actual figure achieved by the end of the budgetary period.
- Variance analysis seeks to determine the reasons for the differences in the actual figures and budgeted figures.
what is adeverse variance?
where the actual figure achieved is worse than the budgeted figure.
An adverse variance in a revenue or profit budget is where the actual figure is lower than the budgeted figure.
An adverse variance in a costs budget is where the actual figure is higher than the budgeted figure.
what are the 3 types of budgets?
- revenue
- costs
- profit
what is favorable variance?
- where the actual figure achieved is better than the budgeted figure.
- A favourable variance in a revenue or profit budget is where the actual figure is higher than the budgeted figure.
- A favourable variance in a costs budget is where the actual figure is lower than the budgeted figure.
what are the limitations of budgeting?
- Budgeting requires significant expertise to be of genuine use to a business and there are several difficulties associated with their construction.
- can lead to conflict and competition.
- encourages the focus on the short term rather than long term.
- can have a negative impact on motivation.
- depends on the data.
how do you calculate gross proft?
revenue - cost of sales
how do u calculate operating profit?
gross profit - operating expenses
how to calculate net profit?
operating costs - interest
whats a statement of comprehensive income (profit loss account)?
- The Statement of Comprehensive Income is an end of year financial statement that shows all of a businesses income and expenses over the previous twelve months.
- Each type of profit is calculated within the Statement of Comprehensive Income
- The previous year’s figures are also shown for comparison purposes
whats a profit margin?
- A profit margin is the amount by which the sales revenue exceeds the costs.
- Profit margins can be compared to previous years to better understand business performance
- Higher and increasing profit margins are preferable as it means that more revenue is being converted to profit
how do you calculate gross profit margin?
gross proft
……………………….-……………………x100
revenue
how do you calculate operating profit margin?
operating costs
—————————x100
revenue
how do you calculate net profit margin
net profit
—————x100
revenue
what are ways to improve profitability?
- raising prices
- reduce costs
- delay time to pay suppliers
whats a statement of financial position (balance sheet)?
- The Statement of Financial Position shows the financial structure of a business at a specific point in time
- It identifies a businesses assets and liabilities and specifies the capital (money) used to fund the business
- contains the financial information required to draw conclusions about the liquidity of the business
define liquidity.
- Liquidity is the ability of a business to meet its short term commitments (e.g. payments to creditors) with its available assets.
- A business that cannot pay its bills will usually fail very quickly, even if they are profitable
- Managing liquidity is a key way to manage risk in a business - and helps a business to prepare for the unexpected
whats a non-current assest?
- items owed by the business long term
- i.e. machinery
whats a current asset?
- items that are converted to cash within 12 months.
- i.e. inventory
whats a non-current liability?
- debts that dont need to be paid within the year
whats a current liability?
- debts that need to be paid within the year
how to you calculate net assets?
assets - liabilities
what are the 2 ways to meausure liquidity?
- acid test ratio
- current ratio
what is current ratio?
- The Current Ratio is a quick way to measure liquidity and the outcome is expressed as a ratio
- The current ratio is an effective liquidity measure for businesses that hold little stock
- The result indicates how many £s of current assets it has available to cover each £1 of short term debt.
current assets
————–a———
current liabilties
what is acid test ratio?
- Is a precise way to measure liquidity and is expressed as a ratio
- The least liquid form of current assets (inventory/stock) is deducted so the acid test ratio provides a more realistic measure of the businesses ability to meet short-term debts quickly
- It is a particularly important measure of liquidity for businesses that hold a large amount of stock
current assets - inventory
————.—————————–
current liabilities
how can you improve liquidity?
- Use cash flow forecasts to identify potential cash flow issues before they arise - and take appropriate action
- Budget effectively and consider adopting zero budgeting to carefully control spending.
- Set clear financial objectives and look for ways to reduce costs and increase income wherever possible.
whats is working capital?
- Working capital is the money that a business has to fund its day to day activities
- current assets - current liabilties
why is too much working capital bad?
- If a business is holding large amounts of cash it is likely to be missing out on the benefits of investing it in fixed assets or investments
- This may represent a significant opportunity cost especially when interest rates are high
- If a business is holding large amounts of inventory it may incur extra storage costs and could use the cash ‘tied up’ in this stock for other purposes
what are internal causes of business failure?
- Ineffective management is a key cause of business failure, leaders may lack the experience or skills to run a business effectively, especially during periods of crisis
- Financial factors (e.g. a lack cash flow or working capital) can cause swift business failure as it becomes difficult to operate on a day-to-day basis
what are external causes of business failure?
- A change in legislation can mean that products or processes may require significant redesign or withdrawal
- Economic challenges (e.g. rising interest rates or a recession) are a key cause of business failure
- The entry of new competitors into a market can cause significant problems for incumbent businesses, who may have to slash prices or spend heavily on promotional activity to maintain their market share
