Theme 2- managing business activities Flashcards
What is the formula for contribution per unit?
Selling price per unit - variable cost per unit
What is the formula for total contribution?
Contribution per unit x quantity sold
What is the definition of contribution?
The difference between the variable cost per unit and selling price per unit
What is break-even?
It compares a firms revenue with its fixed and variable costs to identify the minimum level of sales needed to cover costs
What is the break-even point?
When total fixed costs + total variable costs = total revenue
What is the formula for the break-even output?
Fixed costs / selling price per unit - variable cost per unit
fixed costs / contribution per unit
What is the formula needed to use contribution in order to find profit?
Total contribution - fixed costs = profit
How can one increase the total contribution?
Either sell more units or boost contribution per unit by increasing prices or cutting variable costs
What is a break-even chart?
It is a graph showing the revenue and costs for a business at all possible levels of output. The horizontal axis represents costs for the business and the vertical axis represents costs and sales in pounds.
What is the margin of safety?
The amount by which demand can fall before the firm starts making losses, it is the difference between the actual and the break-even point
How do you calculate the margin of safety?
Sales - break-even point
What are the effects of a price rise on a break-even chart?
- it’s revenue line will rise more steeply than before
- it will lower the break-even output
- it will increase the profit potential at each level of output
What is the effect of a rise in variable costs on a break-even chart?
- the variable costs line rise more steeply and this will affect the total costs and so will the break-even profit, you will have to sell more to achieve the break-even output
What are the advantages of break-even analysis?
- estimate the future level of output they will need to produce and sell in order to meet given profit objectives
- it’s easy and quick to do, managers can see the break-even output and margin of safety immediately so they can take quick actions to cut costs or increase sales if they need to increase their margin of safety
- business can use break-even analysis to help persuade the bank to give them a loan
What are the limitations of break-even analysis?
- the model is too simple. It assumes that variable costs increase constantly, which ignores the benefits of economies of scale
- it assumes that all output is sold, in times of low demand, a firm may have difficulty in selling all that it produces
- break-even analysis assumes that the firm sells all of its output at a single price
What is the purpose of budgets?
- to ensure that no department or individual spends more than the company expects, preventing unpleasant surprises
- to provide a yardstick against which a manager’s success or failure can be measured
- the motivate the staff in a department, budget figures can be used for assessing staff performance, then staff know what they must achieve
What is budgeting?
It is the process of setting targets, covering all aspects of costs and revenues. It is a method for turning a firm’s strategy into reality.
What is a budgeting system?
It shows how much can be spent over a time period and gives managers a way to check whether they are in track.
How do you construct a budget?
- make a judgement of the likely sales revenue for the coming year
- set a cost ceiling that allows for an acceptable level of profit
- budget for the whole company’s costs to then be broken down into each division, this can be then broken down further for each manager
What are the three types of budgeting?
1) revenue budget- sets out expected sales revenue from selling products, includes levels of sales, a start-up would have a lower revenue
2) profit budget- combining revenue and expenditure budgets to get profit/loss, new business only have a profit later
3) expenditure budget- also known as cost/production budget, sets out expected expenditure on monthly basis, plan of costs required for operation of business
What are the two methods for budgeting?
Historical budget
Zero-based budget
What is a historical budget and what are the pros and cons?
This is treating last year’s budget figures as the main determinant of this year’s budget. Minor adjustments will be made for inflation or other foreseeable changes.
Pros: it is quicker, increased efficiency
Cons: may not be very accurate, cannot predict economic changes and so can be risky
What is a zero-based budget and what are the pros and cons?
This sets departments budget as zero and works it way up, it demands that budget holders, in setting their budget, justify every pound they ask for. This helps to common phenomenon of budgets creeping upwards each year.
pros:
- encourages improvement to the business, each department are able to innovate and improve productivity through investing
cons:
- the only serious drawback is that it takes a long time to find good reasons to justify why you need a budget if £150,000 instead of £100,000
- because it is so time-consuming, it is sensible to use it every few years, rather than every year
What is the best criteria for setting budgets?
- relate the budget directly to the business objective, if a business wants to increase sales and market share then the best method may be to increase the advertising budget
- to involve as many people as possible in the process, people will be more committed to reaching the targets
How is a simple budget statement is set out by?
Income Variable costs Fixed costs Total expenditure Profit
What is variance analysis?
The difference between the budget and actual values
Variance is the amount by which the actual result differs from the budgeted figure, it is usually measured each month.
Variances are referred to as adverse or favourable, not positive or negative.
These regular variance statements provide an early warning. If the sales are slipping then the manager might respond by increasing marketing support.
What is favourable variance?
Is one that leads to higher than expected profit (revenue up, costs down)
What is adverse variance?
Is one that reduces profits (costs being higher than budgeted level)
Why do budgets?
- to provide direction, efficiency
- to control income and expenditure, establish priorities
- to monitor performance, motivation
- to enable spending power to be delegated to local managers, local managers know what is best for the individual firms, allows for motivation and speeds up decision making
What are the difficulties of budgeting?
- determining sales is outside the control of the managers in some cases, e.g. Chessington’s sales are weather dependant
- businesses need to decide whether designing and implementing a budgeting system will cost more in terms of time and money that it could save, assess the opportunity costs
- budgets need to be changed as circumstances change, economic cycle
- department rivalry results possibly in short term decisions rather than the right long term decisions
What is profit?
it is the financial gain of a business through trading and can be found by deducting expenditure from revenue
What is the formula for gross profit?
Revenue - cost of sales
What is operating profit?
Gross profit - fixed overheads
What is formula for the profit for the year(net profit)?
Operating profit - net financing and costs
How is a statement of comprehensive income structured?
1) revenue (sppu x q)
2) costs of sales
3) gross profit (revenue - COS)
4) fixed overheads
5) operating profit (gross profit- fixed overheads)
6) corporation tax
7) net profit (operating profit - financing and tax)
How can profitability be measured?
Using gross profit margin, operating profit margin and profit of the year (net profit) margin
Profitability- states profit as a % of sales
How do you calculate gross profit margin?
Gross profit / sales revenue x 100
How do you calculate operating profit margin?
Operating profit / sales revenue x 100
How do you calculate net profit margin?
Net profit / sales revenue x 100
What are the two ways of increasing profits?
Increase revenue
Decrease costs
How can we decrease costs in order to improve profits?
- cutting the costs without damaging the quality in any way
this can be done by: - better bargaining with suppliers
- better ways of producing may lead to higher profits per sale, automation?
- restructuring, delayering and redundancies
- when decreasing the costs the company needs to be careful to ensure that reducing costs does not lead to a deterioration of the service or quality of the product
How can we increase the price in order to improve profitability?
- this would increase the profit by sale, but the danger is that the sales overall may fall so much that the overall business profits are reduced
- the impact of your increase in price depends on the price elasticity of demand, the more price elastic it is, the greater the fall in demand will be
What is the difference between cash and profit?
Cash is the money available, the money circulating round a business at any time, this would not include part of a loan
Profit is the money generated by selling products, revenue - costs
- profit is recorded straight away but cash will not be recorded until it is paid out or received which could be in a different trading year
- a business can trade for many years without a profit but a profitable business may go bust if it runs out of cash to pay a supplier or staff
- to improve profitability a business must either increase revenue or reduce costs but if owner introduce cash via savings or a loan this will not affect the profit figure
How do we distinguish between revenue and cash inflow?
- revenue is not the same as money in. Revenue is the value of sales made over a specific period
- whereas revenue comes from just one source (customers), cash inflow can come from many sources and is not limited to trading (could be from loans)
- taking out a bank loan could not be classed as revenue but it does put cash into your bank account
- so cash inflows can be a part of the revenue, but they don’t have to be
How do we distinguish costs from cash outflow?
costs are the sums of money that are paid out in the whole product life cycle.
there are lots of reasons for cash outflow. Paying for the business costs is only one of them. It also includes dividends or paying out a bank loan.
What is profit utilisation?
The way in which profit is used, I.e, spent between how much is distributed to shareholders and how much is reinvested back into the business, known as retained profits
What is profit quality?
Measure of whether profit is sustainable in the long run. High quality is one that continues and low quality arises from exception circumstances
What is liquidity?
It measures the ability for a firm to find the cash to pay its bills. The cash needs to be available in a current bank account I’d close to being available, such as a payment promised for next week.
How do you measure a business’ liquidity?
The first thing he to identify the bills, these are the liabilities. Then you must measure the assets. If the amount of assets is higher than liabilities then their liquidity is sound.
What is current ratio?
This looks at the relationship between current assets and current liabilities. it shows the liquidity of the business. The desired ratio is 1.5:1. A low current ratio means that they may struggle to repay their debts.
What is the formula for current ratio?
Current assets / current liabilities
What is acid test ratio?
This examines the business’ liquidity position by comparing the current assets and liabilities but omits the stock from the total current assets. The ideal result is 1:1
What is the formula for acid test ratio
(Current assets - inventories) / current liabilities
What are the ways of improving liquidity?
- selling under-used fixed assets
- raising more share capital
- increasing long-term borrowings
- postponing planned investments
- improving the management of working capital
What is working capital and explain its management
it is the finance available for the day-to-day running of the business. They need money in order to buy equipment and to pay staff’s wages.
Managing working capital is about ensuring that cash is sufficient to meet the cash requirements at any one time. If bills cannot be paid on time then they have serious problems.
define the working capital cycle
Managing working capital is a continuous process. When a business starts up, it takes time to generate income. As the business cycle gets going, income from customers will be available to pay for expenditure. the business needs to make sure that there is always sufficient cash to meet daily requirements.
explain the process of the working capital cycle
Whilst capital is being injected into the business:
Sell to customers in credit, customers pay up, buy materials and produce goods
This process is then repeated
Why is working capital important?
- dividend payment
- shows the business’ liquidity
- important short term and long term as it means business’ can survive and grow
- for manufacturing companies, they can incur costs many years before receiving payments, e.g. 2012 olympics
What are the causes of working capital problems?
- poor control of inventories/stock
- unexpected events
- overtrading = a business expanding too quickly without financial reluctancies to support it
- too many short-term loans and overdrafts
What are ways of improving working capital?
- negotiate prices and terms with suppliers
- sell long term assets for cash
- manage stock levels well, e.g. have enough materials for uninterrupted production and minimise re-ordering costs
- cash flow forecasting to plan ahead to know how much cash is needed in the future
What is business failure?
The inability to keep the business going, either because of inability to keep up with the bills/liabilities or because the profits being made are too meagre to be worth continuing
What are forbes’ reasons why new businesses fail?
1) not really in touch with customers through deep dialogue
2) no real differentiation (lacking a unique value proposition)
3) failure to communicate your unique proposition in a concise and compelling way
4) leadership breakdown at the tip (a dysfunctional leader)
5) inability to nail a profitable business model with sufficient revenue streams
What are the 3 internal causes of business failure
1) a marketing failure- businesses must foresee threats and find a marketing solution, finding new products or services to meet the needs of today’s customers, failure to adapt to a new trend
2) a financial failure- this could be done by over-expanding too much in new machinery at a time of declining sales, businesses collapse due to bad management of finances.
3) a systems failure- if a new IT system causes confusion, the result can be disastrous. Stock ordering may go wrong, leaving some empty whilst others overflow.
What are the 4 external causes of business failure?
1) a fundamental change in technology- a rival gets a competitive advantage that is too great to be matched
2) the arrival of a competitor- these competitors may be offering something that you are not and so sales may plummet as they steal all your customers
3) economic change- in 2009 during the recession, the production of cars plummeted, this threatened the future of major car companies due to the lack of sales
4) the behaviour of banks- some banks have been accused of making a profit from client companies in financial difficulties. There are cases of forced closure so that the banks can sell their assets to make a profit.
What are the financial causes of business failure?
There are two triggers to financial failure: the one is the inability to pay bills and the other is the result of a big investment going spectacularly wrong.
Most financial collapses, though, are due to running out of cash, this can be because of:
1) the business may have been running below break-even for some period. If the business cannot be returned to profit, cash will run out at some point.
2) a cash flow crisis may occurs, perhaps unexpectedly. If a company manages to get distributed by a big company and then they decide to stop selling their products then the company may have to turn for finance but if the banks are insisting that an overdraft needs to be payed within 24 hours then they may be forced to close down
3) overtrading- if a rise in demand encourages a business to pursue rapid sales growth, the strain on cash flow can prove too great, causing the company to collapse
What are the non-financial causes of business failure?
The two main causes are a suffer lurch in sales towards competitors or a steady loss of sales as the business loses its long-term competitiveness
1) poor management of people or operations as this can lead to IT failures and poor customer service from unhappy employees
2) thriving competitors and steady sales decline
How is a statement of financial position/balance sheet structured?
1) Non current assets
2) Current assets
3) Current liabilities
4) Working capital (CA-CL)
5) Non current liabilities
6) Net assets (NCA+WC-NCL)
7) Financed by
8) Total equity (should balance with net assets)
What is a statement of comprehensive income?
- it sets out the revenues generation in the year together with all the costs incurred
- PLCs and LTDs need to publish their accounts every year by law
- as part of those financial accounts they need to show their profit and loss and this appears in their SOCI
What is a current asset?
Own for a short period
- assets that are quickly and easily turned into cash
e.g. cash and stock
What is a current liability?
Owe within a year
Short term loan, customer deposits
What is a NCA/fixed asset?
own for more than a year
Machinery
Property
What is a NCL
owe for more than a year
Long term loans
mortgages
what part of an income statement are employees interested in and why
net profit
- see if their wages go up
what part of an income statement are the government interested in and why
profit before tax
- see how much the business should pay in tax
what part of an income statement are shareholders interested in and why
net profit
- see their dividends
what part of an income statement are managers interested in and why
operating profit/net profit
- see if high costs are limiting the business, see how much they will have to spend
what part of an income statement are suppliers interested in and why
net profit
- see if the business has the funds
what part of an income statement are potential shareholders interested in and why
net profit
- see if theres a steady stream of money coming in
what is return on capital employed (ROCE)
operating proft / capital employed (total equity + NCL)
- the higher the better
- measure firms efficiency
- investors can look at likely returns
it is improved by:
- increasing operating profit
- reducing capital employed
what are the two aspects of finance?
it can provide the numbers that help managers to make better decisions, and it can count what is happening and what has happened.
what is working capital?
the money that is left for the day-to-day running of the business
what are the 3 key financial concerns for new business start-ups?
1) How much will it cost to get a business idea to opening the doors on the first day
2) How much the running costs will be, they need a solid understanding of the fixed and variable costs
3) How much revenue can you expect from the customers you serve?
what are two methods of raising finance for the short term?
bank overdraft
trade credit
what are two methods of raising finance for the medium term?
bank loan
leasing
what are four methods of raising finance for the long term?
owners’ savings
sales of shares
reinvested profits
venture capital loans
how does a venture capital company make its money?
By investing in many businesses with great potential, some may disappoint but as along as successes have a big upside, they can be sold off for profits big enough to cover the disappointment.
identify three situation when a business might want/need to raise finance
- purchase materials
- pay staff
- R and D
- innovate
what is internal finance and what are the 3 ways?
this is money that comes from inside the business
retained profit
sales of assets
owners capital: personal savings
explain the internal source of finance of retained profit
- any profit left in the business after the cost of sales, fixed costs, tax and financing costs have been paid. It is often used to re-invest in the business.
- this is the profit made by the business in earlier years. It is the money kept in the business rather than paying it out as dividends.
- it is the best way to finance investment into a firm’s future
- logically then, the higher the profit the more likely it is that it can finance its expansion from within
explain the internal source of finance of sales of assets
- This is using a business’ assets and selling them off. They may say buildings, land, vehicles and machinery that is no longer needed
- It is a way of upgrading and is a quick way to earn cash at 0% interest
- This may cause future problems if you need it later
explain the internal source of finance of owners capital: personal savings
- This is the money put into a business by its owner or owners. This is often used when a business is first set up
- This is limited as not many will have the sufficient fundings in order to successfully rely solely on this
what are the 6 sources of external finance?
family and friends banks peer-to-peer funding business angels crowd funding other businesses
what are the 7 methods of external finance?
loans share capital venture capital overdrafts leasing trade credit grants
explain the external source of finance of family and friends and what are the pros and cons
- they can provide share capital (through the selling of shares) or can lend money
- a sole trader or partnership may find that their family want to contribute to the business. this may be for interest, a share of the profits or maybe even an interest free loan amongst family
- the majority of businesses start with a combination of owners’ capital and family and friends
pros:
- loans from family and friends will probably be offered without the need for security and at lower rates and over longer terms
- they are unlikely to need a business plan and so can save the time of not wiring one
cons:
- You may feel pressure on the relationship, what happens to the friend or member of family will affect them
- they may demand their money back at short notice
explain the external source of finance of banks and their pros and cons
- banks may lend a loan to a business to start-up or when a business wants to grow and expand
- borrowing a large sum of money to pay interest on the money you owe
- banks may also provide a business with an overdraft to help hen they have cash flow problems
pros:
- repayment plans available to suit the business
- banks will allow the business to continue running in their own way, not interfere, owners retain control of the business (unlike business angels)
cons:
- if it is a start-up business then the owner may need to use their own assets as security for the loan (e.g. their house)
- loans can be very expensive compared to other sources, interest must be paid back on time
explain the external source of finance of peer-to-peer funding
- matches businesses that need funding with investors who are looking for a good return on their investment
- this was very popular after the 2009 recession when banks were reluctant to lend money
- lending marketplaces such as funding circle have gained the trust of consumers by offering lower rates than banks to business owners who want to borrow money
pros:
- businesses can’t access to funding within a week once approved
- investors can expect returns of 6-7% whereas a savings account might only give them 3%
cons:
- if there are not enough individuals interested or willing to invest in your loan, you may not be able to acquire the entire amount that the business needs
- the money for the loan comes from several investors, it is classified as a private business loan so you are tied up with several companies
explain the external source of finance of business angels
- Individuals who invest in the early stages of a riskier business and take an equity share in return for providing finance, advice and guidance
- an angel investor offers to lend their personal disposable income, normally in exchange for shares in the business
- angel investors take huge risks in the hope of an occasional blockbuster success
- usually smaller loan amounts than a venture capitalist
pros:
- the owner gets access to angels’ mentoring and management skills
- the owner will have no repayments or interest on the money lent
cons:
- owner needs to give a share fo the business
- not suitable for investments below £10,000 or above £500,000
explain the external source of finance of crowd funding
- a way of getting small investors to put money into a new product over the internet
- the three ways to fund are through:
1) donate- no money back but rewards like tickets or free samples
2) lend- gets money back with interest and satisfaction of contributing to success of a small business
3) invest- invest tin the business in exchange for equity or shares which may go up in value - it is more successful when the sponsors use social media to promote their firm
pros:
- the business can generate funds and also promote the business at the same time
- good alternative to loans for small business owners
cons:
- the firm will need to showcase their idea to investors and may need to put together a video and other promotional material, cost
- takes much longer to happen than a loan, is not always successful
explain the external source of finance of other businesses
- some large MNC’s are willing to invest in innovative start-ups, the companies hope to get the occasional winner among a number of duds
- In Silicon Valley, USA, this type of investment is common, but not in the UK
what is an external source of finance?
if the business is unable to generate sufficient funds from internal sources then it may need to look to external sources. there are two sources of external capital: loan capital (debt) and share capital (equity).
- loan capital carries interest rates and must be repaid in a specific time schedule
- share capital is usually rewarded by annual dividend payments, but the directors have the flexibility to cut or scrap those payments in a difficult year
explain the method of external finance of loans and its positives and negatives
- loaning money from a bank is like ‘renting’ money
- banks will lend to small businesses but may not lend when they first start-up as there is no track record or history of them making money
- The loan is set for a period of time, either being short, medium or long term. It can be paid in instalments or at the end of the period. The bank will ask for collateral to provide security if the loan cannot be repaid.
- loans are affected by interest rates- if they go up then the cost of borrowing will go up too
Positives:
- Easy to do and repayment plans available to suit the business
- as the loan is fixed for a certain length of time, the firm can produce a successful cash flow forecast, they know when and how much money will go out the business
Negatives:
- They may ask for collateral- an asset belonging to the business so is risky
- if interest rates go up then it can become an expensive source of finance
explain the method of external finance of share capital and what are the pros and cons?
- this is when a PLC makes money from the selling of shares
- If the business is a limited company, it may look for additional share capital, it can come from private investors or venture capital funds.
- Once it has become a public limited company, the firm may consider floating on the stock exchange.
Positives:
- investors are often prepared to provide extra funding as the business grows
- it can bring wise heads into boardroom
Negatives:
- the more shares sold, the more the profits have to be divided up and paid out to investors as dividends
- potential investors may require a great deal of background information before the buy the shares
explain the method of external finance of venture capital and what are the pros and cons?
- Venture capitalists invest in smaller, riskier companies with a large sum of money but in return they demand a substantial part of the ownership of the company.
- they will look for a high rate of return in a specific time period
- it is good for any start-up or early stage business that is unable to raise finance through the stock markets or from banks
- they will invest at least £50k but this can rise into millions of pounds
Pros:
- useful if the business is looking to raise a large amount of money in a short space of time, banks would not offer this
- Venture capitalists can provide advice, expertise and contacts
Cons:
- venture capital firms typically want a 20-30% stake in the business
- venture capital firms look for a strong business plan and a proven track record, making it difficult for start-up firms
explain the method of external finance of trade credit and what are the pros and cons
- When a business obtains goods and services from another business but does not pay for these immediately
- Suitable for businesses buying raw materials and stock, the buyer will have time to sell their goods in their own shop before they have to pay for them
- the wholesaler may give the buyer a discount when they use cash instead
Pros:
- no interest has to be paid on trade credit
- businesses that pay regularly on time build relationships with their supplier and secure better deals
Cons:
- if the business doesn’t pay on time then they risk being refused further credit by the supplier in the future
- not all stock is available to buy on trade credit, only applies to certain industries
explain the method of external finance of grants and what are the pros and cons?
- they are hand-outs to small firms who are making a positive difference in the community, they are given to encourage a start-up or a relocation that is considered as valuable
- they are only available to businesses that qualify, e.g. if they are providing jobs in an area of high unemployment or helping people develop skills
Pros:
- the business will not have to pay back the grant, no interest
- can be used to aid growth and increase revenue
- they will get funds without any loss of control of the business
Cons:
- there’s a lot of competition for grants, difficult to obtain one, need a successful proposal
- Often just a one-off payment, short-term
explain the method of external finance of leasing and what are the pros and cons?
- Leasing an asset means agreeing to pay a fixed monthly rental for a fixed period, such as three years, an asset is rented rather than purchased
- You end up paying more than what the product is worth but at least you have kept the cash in your bank account at the start of the period
- In the long term, leasing is more sensible than buying the asset in terms of your cash flow
pros:
- improves cash flow as it comes out in small amounts, not a shock for the business
- allows you to buy more expensive equipment due to the repayment plans
negatives:
- pricey, in the long term it is more expensive
- needs to hope that they continue earning enough to repay
explain the method of external finance of overdrafts
- An overdraft is a very short-term loan, where depositors can go into a negative balance in the bank account, it is ‘extra cash available’
- it may be organised by the bank which is short term lending of smaller amounts of money
- once it is arranged, it is an account business can dip Inyo or pay it back as they see fit
Positives:
- seen as a quick fix method to help a business over a difficult month of trading, very flexible, suited to the difficult cash flow position of start-ups
- the business will only pay interest on the amount of money that they are overdrawn, easily pay back the overdraft
Negatives:
- very risky, banks can cancel them at any time, often leading to the business not being able to repay the negative balance, leading to administration
- very expensive source of finance, higher interest rates than loans, high charges
what is unlimited liability?
When a business and its owner are the same legal entity. In this case the debts of the business are the debts of the owners, and personal property can be sold to pay the debts of the business
- If the business goes into a lot of debt and they cannot repay, the owner may be forced to sell their houses, cars, etc.
- If the owners cannot pay, they can be made personally bankrupt
- The two types of business organisation with unlimited liability are sole traders and partnerships
what are the four methods of finance appropriate for businesses with unlimited liability?
1) Owners’ capital- in the case of a partnership, an agreement may be drawn up basing the proportionate ownership of the business on the amount of capital invested by each partner
2) Bank finance, either loan or overdraft- it is easier for them to obtain bank finance because even if the business fails, the bank can recoup its cash form the personal assets of the owners
3) Leasing- signing an agreement to rent a specific asset for a specific period, therefore avoiding the cash drain caused by purchase
4) Trade credit- supplier companies wold often prefer a deal with a sole trader or partnership as they know they can recoup any debts from the individual owners if the business fails
what is limited lability?
When a business is a separate legal identity to its owners, which means that if the business goes bankrupt the owners only lose what they originally put into the business, and not their personal belongings
if the company has lots of debt the courts can force them to sell all their assets (computers, cars) and if there is still not enough money, the company is closed down but the owner/shareholders have no personal liability for the remaining debts
what does limited liability do?
- Limited liability can give owners the confidence to push their business to the next level, financed by bank loans to give security
- However these are a huge scope to fraud. They can start a business, take customers’ money, enjoy a fantastic lifestyle and then go into liquidation before the customers receive the services they paid for
what are the 5 sources of finance for limited liability businesses?
1) Share capital- part of it may be under the control of the founder and part sold onto family and friends or more publicly to the general public
2) Bank finance through bank loans and overdrafts- will have to be backed by specific collateral, especially for small companies. It is highly likely that a bank would demand a personal guarantee by the founder shareholder
3) Angel or venture capital investment- the founder suffers dilution of control over the business and they will find that loan capital is at a much higher interest rate than a regular bank loan
4) Peer-to-peer or crowdfunding- both these sources tend to keep control more effectively in the hands of the founder
5) Leasing and trade credit
explain the relevance of a business plan in obtaining finance
- The business plan helps the entrepreneur to focus on what she or he is trying to achieve.
- The plan will help the outsider understand the risks and rewards involved in the proposal
- The financier will want to see a carefully prepared plan with a well-considered proposal for the sums of money needed. Without a business plan the financier won’t trust the business’ objectives as they cannot see evidence that shows that it is likely to succeed, after all you are borrowing money from them to then eventually be able to repay
what should the business plan be based around and what are the main sections?
it should be based on competitive advantage which means identifying the features of your product that will make it succeed against competitors
It includes:
1) Executive summary: short and compelling to make the busy banker read on, needs to tell what you want and how you will ‘relieve’ it
2) The product/service: explain it from the customers’ point of view, what is different about your idea compared to competitors
3) The market: analysis of competitors, focus on market trends rather than market size
4) Marketing plan: who your market is, how you will advertise, the cost
5) Operational plan: how will the product be produced and delivered
6) Financial plan: CASH FLOW FORECAST, projections on revenue, costs and profits
7) Conclusion: ideas of the longer-term plans for the business
what is a cash flow forecast and how is it structured?
A cash flow forecast is carried out by estimating all the money coming into and out of the business.
- it shows where the business will have a shortfall of cash
1) Opening balance
2) Cash inflow
3) Cash outflow
4) Net cash flow (inflows - outflows)
5) Closing balance
what is cash inflow?
these are the sums expected to arrive each month
- this is normally the sales revenue
- it appears on the top of the cash flow forecast
what is cash outflow?
the planned payments each month, this includes both fixed and variable costs
- this is known as expenditure
- this will be bills such as wages, insurance and advertising
what is opening and closing balance?
the closing balance is the opening balance plus the net cash flow, the closing balance shows the overall state of the bank account at the end of the month
The opening balance is how much money a business has in the bank at the start of the time period
what are the 4 ways of improving your cash flow forecast?
- Production and distribution should be as efficient as possible to get the goods to the market in the shortest amount of time
- Get paid more quickly, early payment should be encouraged by offering incentives
- Keeping stocks of raw materials to a minimum, use just-in-time stock management
- Find new sources of cash inflows to generate money
what are the uses of cash-flow forecasts?
- Managers can identify times the business may be short of cash, arrange suitable finance, e.g. an overdraft
- Managers can take suitable actions to avoid cash shortages becoming a major problem, cut costs
- A way of measuring performance at the end of the year, comparisons between predicted inflows and outflows with what actually happened
- it may help the owner to secure a better deal on their finance, e.g. lower rate loan
what are the 4 limitations of cash-flow forecasts?
- only a 12 month snapshot which is very short-term to make any concrete decisions about the business, they may need longer term finance
- it is only a forecast, they are only as good as the raw data put in, entrepreneurs need to be optimistic by nature and so they may overestimate sales and underestimate operational difficulties (and therefore cash outflows)
- they risk giving the impression of certainty where none exists, as a start-up you can’t predict how long business customers will take to pay, can be risky for an investor to make decisions about the business on just the cash flow forecast alone, need a balance sheet
- it is vital to allow for contingencies- things that can go wrong. A clever cash flow forecast includes a planned overstatement of costs, to allow for unexpected problems
what is the purpose of sales forecasts?
1) avoid cash flow problems- accurately forecasting the sales can help a business to manage their production, staff and financing, avoid unforeseen cash flow problems
2) start promotional activity- if they are forecasted to have low sales then they may decide to try and increase sales through promotional activity if they are not in the decline phase of the product lifecycle
3) production capacity- use their sales forecast to decide whether to increase or decrease production, plan for changes in the industry, see if they have enough production capacity to meet demand (may need to buy or rent new premises), run more efficiently by selling excess inventory
4) frees up management time- by having a well-constructed sales forecast they can spend more time developing their business rather than responding to developments in sales, focus on other sectors of the business, increase customer service and therefore profits
what are the 3 factors that affect sales forecasts?
consumer trends
economic variables
actions of competitors
explain the factor that affects sales forecasts: consumer trends
- Consumer tastes and habits change over time and these changes can be quite dramatic
- A natural way for a forecaster to deal with this is to plot the past trends and then consider what the likely future pattern will look like
- The factors that affect medium-to-long term consumer trends include: the changing tastes and habits, demographics, globalisation and the affluence of a population
- documents like intel can help a business to identify an upcoming trend
- trade fairs are also ways that a business can research what might be new popular products
explain the factor that affects sales forecasts: economic variables
- Some products are highly sensitive because their income elasticity is high, their sales are heavily dependent on changes in consumers’ real incomes
- Variable that can affect a sales forecast include: interest rates, inflation, unemployment and GDP
- some sales contracts may not be renewed due to inflation and the rising costs of the products for the business
- if the UK economy is in the recovery phase then low cost retailers like poundland may need to forecast lower sales
explain the factor that affects sales forecasts: actions of competitors
- It is very difficult to predict the actions of competitors and so this is a barrier to making successful sales forecasting
- The arrival of competitors can majorly alter the sales of a business
- hard to predict but often significant reason why sales forecasts prove over-optimistic
- if a business has products with declining sales perhaps due to a competitor’s superior product then they might decide to produce less of those products
what is extrapolation in sales forecasting?
assuming that the pattern of future sales will continue to follow recent trends
what are the 3 difficulties of sales forecasting?
1) no guarantees
- just because a sales forecast has been written by a business, there are no guarantees that sales will meet these levels
- this could be down to a number of uncertain factors: the economic climate, the impact of terroism on tourism in some countries
2) dynamic markets
- most markets are constantly changing (technology) and so it is difficult to produce an accurate sales forecast
- the arrival of a new competitor or a change in consumer trends would majorly impact sales, cannot predict
3) sales of products may change depending on weather and seasons and we cannot predict what the weather will be like and so it is hard to forecast sales, e.g. chessington
what is revenue?
the value for total sales made by business within a period, usually a year
what are costs?
the expenses incurred by a firm in producing and selling is products, such as wages and raw materials
what are the two ways of measuring sales?
by volume and value
- Sales volume is simply the number of units sold.
- Sales revenue is what those units were sold for, volume x price
- It is hard to calculate sales revenue as many products are sold on credit, scope for uncertainty
explain business revenue
The revenue received by a firm as a result of trading activities is a critical factor in its success. Entrepreneurs start their financial planning by assessing the revenue they are likely to receive.
- Those seeking to increase their revenue can plan to sell more or aim to sell at a higher price.
- Another way to boost revenue is to charge a low price in attempt to sell as many units as possible, this may lead to high revenues and profits. This is often done when there are lots of competitors selling very similar products.
- Online purchasing makes variable pricing more common by being able to raise and lower prices depending on supply and demand conditions. This is a way to maximise revenue.
explain the costs of production
- They need to know the cost of production to assess whether it is profitable to supply the market at the current price
- They need to know actual costs to allow comparisons with their forecasted figures
what are fixed costs?
any costs that do not vary directly with the level of output.
- They are linked to time rather than to level of business activity and exist even if a business is not producing any goods or services.
- Fixed terms can alter over time, expansion may lead to an increased need of factory space and so rent would go up
- examples include: rent, utility, management salaries
what are variable costs?
those costs which vary directly with the level of output.
- They represent payments made for the use of inputs such as raw materials, fuel and labour
- A doubling of the sales would of led to the doubling of the raw materials used
- It is not always the case that variable costs rise in proportion to the output. This could be due to the use of economies of scale.
how do you calculate total costs?
fixed costs + variable costs
what is job production?
when the complete task is handled by a single worker or group of workers. This is a bespoke service and is tailor-made to suit the specific requirements of the customers.
what are the characteristics of jobs production?
- e.g. designer products
- unique
- labour-intensive
- high-skilled
- high value
what is batch production?
this requires that the work for any task is divided into parts or operations and produces a set of identical items. it usually involves division of labour whereby tasks are divided between employees.
what are the characteristics of bath production?
- used in the production of electronics
- concentrate skills (specialisation)
- e.g. food industry
- better use of equipment
what is flow production?
It is the continuous production of a single standardised product
method where the task is worked on continuously or where the processing of material is continuous and progressive. it is the most efficient way to produce an idea with predictable, high-volume sales
what are the characteristics of flow production?
- very quick and efficient
- e.g. car industry
- highly automated
- economies of scale
- identical products
