Theme 2 Knowledge to date Flashcards
Name 5 sources of finance?
Overdraft, Trade Credit, Retained profit in the form of cash reserves, Mortgage, Bank Loan, Selling Shares
What is meant by unlimited liability?
If the business goes Bankrupt then any money awed to suppliers or the bank can be recovered through repossession of owners personal assets. This will only happen if the company does not have enough assets to cover the amounts owing
Explain why a loan might not be appropriate for a business with unlimited liability
This will add further risk to the owners as it places pressure on the business to make regular payments which reduces cash reserves meaning that they may lack sufficient current assets to pay current liabilities risking liquidation which might then risk personal possessions.
Explain how having unlimited liability impacts a business’ ability to gain credit from suppliers
If a business has unlimited liability it could work in their favour for getting credit from suppliers as the supplier will have the added security of collateral if the credit is not repaid. The supplier will know that they can recover any debt from the owners personal assets
Why might banks be reluctant to provide a loan to a business with limited liability?
As if the business lacks sufficient assets to cover the cost of the loan then the bank will lose that capital as they can’t recover it from the owner’s personal possessions
Explain the difference between an overdraft and a bank loan
An overdraft has a higher interest rate but is more flexible as the business can choose when they pay it off and by how much they pay off. However the bank can remove the overdraft at any time and ask the business for the amount owing. With a loan the repayments are fixed and the business must make regular monthly payments.
What is the difference when a business uses share capital as a source of finance compared to using a venture capitalist?
A business needs to be a limited company to sell shares and will usually sell a small proportion of the business in one issue compared with raising money through a VC which involves giving up a significant part of the business (sometimes as much as 50%) in exchange for capital and advice/ experience. When a business issues shares the shareholders (particularly for a PLC) will probably have limited involvement in the business
Explain why using retained profit as a source of finance may not be a favourable option for a PLC
If the business uses retained profit as a source of finance then the businesses share price may fall as it may mean that they reduce dividend payments which makes investing in the business (buying shares) less popular reducing demand for the shares and therefore reducing share price
Explain how a business’ legal structure can have an impact on the source of finance a business chooses to use
If a business is a limited company they can issue shares and will attract more investors than a partnership and sole trader due to the reduced risk gained through limited liability status. Where as Partnerships and sole traders cannot sell shares and will struggle to attract investment due the unlimited liability status. Therefore they are more reliant on venture capitalists and loans.
Identify three short term sources of finance
Overdraft, Trade Credit, Retained profit in the form of cash reserves
Identify three long term sources of finance
Mortgage, Bank Loan, Selling Shares
What is meant by working capital and why is it important when choosing a source of finance?
Working capital is the value of current assets that are left over after the current liabilities have been paid. If a business has high working capital it shows that it is at low risk of having cash flow problems and is therefore able to safely take out a loan as it is likely to keep up with loan repayments as it is likely to have sufficient cash in reserves. This reduced risk is recognised by banks and shareholders meaning they are willing to provide the capital. A low risk business will usually get a lower rate of interest on loans and be able to sell shares at a higher price.
Why might a bank be more reluctant to lend money to a new restaurant than they are to other new businesses?
A restaurant is likely to provide luxury goods meaning that they are income elastic which means that sales could significantly fall if incomes fall due to changes in the economy. Therefore they are venerable to economic changes adding to the risk for the bank. If the country goes into a recession the business may struggle to pay the loan back.
Why might an overdraft be an appropriate source of finance for a new business?
A new business will not have past sales data and will have limited experience in the market. Therefore it will be difficult to predict sales. Therefore it will be difficult to predict cash outflows like wages and cost of raw materials. Therefore they need flexible finance that they can use as and when required rather than committing to regular monthly repayments
Why may a sales boom lead to the business going bankrupt?
To gain the sales boom the business may have overinvested into fixed assets such as vehicles and equipment causing significant cash outflows resulting in negative net cash flow making it difficult to keep up with payments to suppliers and banks. This may lead to the business being forced to sell fixed assets to the point that it can no longer function.
Why might it be argued that a business should not keep large sums of cash?
There is an opportunity cost of keeping large sums of cash as this means the business it not fully utilising their capital as it could be making a greater return if invested in fixed assets. As the fixed assets such as a store or equipment could be increasing sales due to increased capacity. Or the capital could be invested in advertising or training of staff which would also increase sales - explain how
Where can a new business go for capital if the bank says no and they don’t have any friends, family or savings?
venture capitalist - but the VA will know the high risk nature of a business like this and will want high returns so will request a large share of the business
Why might a business be reluctant to take out an overdraft?
As there are significantly high interest payments. It can also be taken off them at a short notice which may mean the business will have to sell fixed assets in order to repay it
Why might a business choose to buy equipment rather than lease it?
This will be better for long term cash flow as there will be will not be regular cash outflows
Why might a business source finance using debt rather than equity?
So the business doesn’t have to give up shares so they can maintain complete control over the objectives of the organisation rather than having to consider potentially short term goals of shareholders
What is meant by collateral and why is it important to a business?
Collateral is when a business places a fixed asset down as security for a loan. This says to the bank that if the loan is not paid they have legal ownership of the asset
Why might suppliers refuse to give credit to a small company?
A small organisation might have few fixed assets therefore if they struggle to pay the supplier there is a risk that the supplier will not receive payment for the goods as there will be limited fixed assets that the business can sell to repay the debt
Why do some companies pay dividend rather than keeping large amounts of retained profits?
When a business pays dividend it makes investments in the company more attractive to shareholders as they will gain an increased return on their investment. This will increase the demand for shares leading to an increase in share price. This will benefit the business as it will mean they can generate more capital from selling shares if they issue new shares leading to further expansion.
I have a high interest rate and can be reduced or taken away with very little notice. What source of finance am I?
Overdraft
Using this source of finance may have an opportunity cost
Cash reserves or retained profit
I have to be secured against an asset
Mortgage
I give up a percentage of ownership in return for investment and advice.
venture capitalist
Using the internet I can attract a significant number of investors for small businesses
Crowed funding
Explain why a business plan might be needed to secure finance for a new business
The business plan, if backed up by effective and reliable research (e.g. with large sample sizes and not prone to bias) the business plan can show the bank how the loan will be invested and how the business plans to repay the loan. The key section is the finance section that will show the cash flow forecast and if the closing balance can remain largely positive when paying off the loan then it is likely that the bank will view the lender as a lower risk. The business plan could be so convincing (especially if based on creditable research) that the bank may reduce the interest on the loan.
Why might a business plan not be enough to secure finance from a bank?
Just because the business produces a business plan it does not guarantee them a loan as the plan might be based on inaccurate research or demonstrate poor cash flow. It could also illustrate that the business has a significant amount of competition with ineffective ways of dealing with the situation
The shares of a private limited company cannot be bought and sold without the agreement of the other directors. Explain the benefit of this
This means that anyone who buys shares and becomes an owner is likely to share the same goals as the existing owners/directors. This could be a passion for the long term prospects for the business or a commitment to social and ethical objectives rather than a pursuit of short term goals and profit for dividends.
“Without the legal protections of limited liability, economies would struggle to grow.” Explain why someone may agree with this statement.
The limited liability status means that investors are attracted to buying shares in businesses due to the reduced risk (there will be no chance that they could lose their personal possessions). This therefore increases the demand for shares leading to increased investment. Due to the increased investment businesses have more capital available to expand capacity which means they can produce more leading to an increase in GDP - economic growth
Which part of a business plan is important to obtaining a bank loan and why?
The cash flow forecast as it shows the projected sales a business expects as well as a clear plan on how the loan repayments will affect their cash balance (closing balance) month to month
What is a cash flow forecast and what are the main headings in one?
A cash flow forecasts shows projected inflows and outflows of a business over time (usually a year) and has the following headings: Inflows, Outflows, Net Cash Flow, Opening balance, Closing balance. Do you know how to work out net cash flow, opening balance and closing balance?
How can cash flow forecasts be used to help a seasonal business?
The cash flow forecast, if based on accurate sales forecasts, will show the business when sales are expected to be low and identify when there may be a negative net cash flow. If a business knows this in advance they can possibly arrange an overdraft to ensure they can continue trading (pay day to day expenses). It may also alert the business to the fact that they may need to arrange trade credit with their supplier to help stockpile goods before the peak season. Showing the forecast and how the credit will be paid could help convince the supplier to give credit
What should cash flow forecasts be supported by?
detailed market research so if that is primary research there needs to be a large sample size and the results need to be unbiased. Secondary research needs to also be reliable and relevant so must be based on the market or relate to a similar business
How can cash flow forecasts be used to improve stock management?
The cash flow forecasts can show the business when sales should increase so they can order sufficient stock. It can also illustrate the implications of having too much stock as it will demonstrate the costs associated with storing stock such as insurance, rent and utilities
Identify the key terms you should include in an answer to a question which requires you to assess the impact that a decision has on finance.
Cash, Liquidity, Profit, Profitability, costs, capital, equity, share price, assets, liabilities, dividends. NOT “INCREASE IN FINANCE”
What is sales forecasting?
A sales forecast is an attempt by management to estimate the likely sales of a product, business unit or market over a future period.
identify three factors that could cause inaccurate sales forecasting
New business with a lack of market knowledge of previous sales to extrapolate. Business that sells luxury goods (income elastic) a highly dynamic market. Market research that is based on a small sample size.
Why are sales forecasts important to planning human resources?
If a business knows the sales that it could possibly achieve then it needs to means to achieve them. Therefore it needs the capacity, therefore it needs to recruit the right number of people. Or if sales are expected to fall then the business will need to reduce capacity so they will therefore need to plan redundancies. If there is expected to be a significant rise in sales in a new market then they may need to plan training or recruitment of employees so they have the capability of meeting needs in the new market
What is meant by a trend and how is this useful to a business?
A trend is a pattern in sales data and it can be used to predict sales for the future by extrapolating the trend. Make sure you know why it is important for a business to know what sales are likely to do.
State three economic variables that might affect the sales forecasts of a business
Inflation (having an impact on demand and costs), interest rates and exchange rates
Why might it be easy for Heinz to forecast sales for its ketchup?
As the company has many years worth of sales data that it can analyse and identify a clear stable trend (sales generally remain the same from year to year) therefore they can carry out effective extrapolation resulting in reliable predictions
What is meant by time series data?
A method that allows a business to predict future sales using past data
What is meant by extrapolation?
Forecasting future trends based on past data
What is meant by seasonal fluctuations?
This is when demand is determined by the time of year for example smaller quantities may be purchased in winter than summer
What is meant by cyclical fluctuations?
This is when sales change as a result of changes in the economy (the business cycle).Recession, Recovery, Boom, Downturn (must know these to get this answer correct)
What is a long term trend?
When a habit or behaviour shows little change over time. For example consumers like to watch TV on demand
What is meant by a data range and how can it affect sales forecasting?
This is the amount of data that is available for analysis. If there is significant amount
Identify 2 ways that sales can be measured
Value and Volume
Give an example of a variable cost
Raw materials
Give an example of a fixed cost
Rent, business rates (tax on buildings), Salaries, Utilities, advertising expenses
Explain the difference between fixed and variable costs
Fixed costs don’t change when output changes and variable costs do change when output changes
How do you work out average costs or unit costs?
All costs divided by the number of units
What is the difference between sales volume and sales revenue?
Sales volume is the amount of units sold and revenue is the amount of money generated from these sales
State three limitations of break-even analysis
Might be based on inaccurate data, does not account for economies of scale (see rest of text), only looks at data from one product. The costs could change which will change the break-even point meaning the decision to chose a particular product to produce may be based on inaccurate data. Costs may change due to change in the price of raw materials (variable costs) or change in the cost of rent (fixed cost). Also it does not account for purchasing economies of scale where variable costs should fall per unit as output increases.
State three uses of break-even
Decision making tool: can help decide on which product to produce (the one with the lowest break-even point or the one that has the largest margin of safety when compared to sales forecasts). Can see the impact of a price change. Can see impact of a change in supplier. Can see impact of a change in production location
What is the difference between a plan and a forecast?
A plan is based on what the business aims to achieve where as a forecast in based on what past and current data predicts will happen. A budget is a plan not a forecast
How can budgets be used to motivate employees? What motivational theory could this be related to?
A budget can set targets for employees such as sales targets or cost targets (keep costs to a minimum) and of these are achieved then the employees can be given performance related pay which Taylor would argue is motivational. Could also be seen as a sense of achievement being felt when the targets are met which would meet esteem needs in Maslow’s theory.
What is the equation for contribution per unit?
Selling price - variable cost
What is meant by the term contribution?
It is the amount that is left over from sales once the variable costs have been covered. It is call contribution as the amount is used to contribute to the fixed costs until they are covered - broke even
What is the equation for total contribution?
total sales revenue - total variable costs
What is the equation for margin of safety?
total output - break-even point
How can Break-Even be used to assess the impact of a price change?
A business can then calculate the new contribution per unit which can be used to calculate a new break-even point which will then change the margin of safety and show how likely the business is to avoid making or loss of how much profit they are likely to make by looking at the money generated between the break-even and the total output.
How can a business reduce the break-even point?
Change premises (reduce fixed cost), make production more automated (reduced wages and therefore fixed costs), reduce waste relating to utilities (reduce fixed costs), change supplier or negotiate lower prices (reduce variable costs), change raw materials used in production (reduce variable costs), increase the selling price (increase CPU)
