Topic 5 - Finance Flashcards
What is breakeven?
understanding the breakeven position is key to understanding what a business needs to do to operate profitably
Contribution
- looks at the profit made on individual products
- it is used in calculating how many items need to be sold to cover all the business’ total costs
Contribution Formula
total sales - total variable costs
contribution per unit x number of units sold
Contribution per Unit Formula
selling price per unit - variable costs per unit
Profit
contribution - fixed costs
Breakeven Chart
(Look at book)
What is the margin of safety?
is the actual difference between the actual output and the breakeven output
What is a budget?
a financial plan for the future concerning the revenues and costs of a business
Uses of budgets in management
- allocate resources
- communicate targets
- motivate staff
- improve efficiency
- forecast outcomes
- provides direction
- control income and expenditure
Two main approaches to budgeting
Historical Budgeting
Zero Budgeting
What is historical budgeting?
- use last years figures as the basis for the budget
- realistic in that it is based on actual results
- circumstances may have changed
- does not encourage efficiency
What is zero budgeting?
- budgeted costs and revenues are set to zero
- budget is based on new proposals for sales and costs
- makes budgeting more complicated and time-consuming, but potentially more realistic
Three Main Types of Budget
Revenue (or income)
Cost (or expenditure)
Profit
Two Key Sources of Information for Budgets
- financial performance in previous periods
- market research
Variance Analysis
calculating and investigating the difference between actual results and the budget
Variances can be…
- positive/ favourable (better than expected)
- adverse/ unfavourable (worse than expected)
Favourable Variances
- actual figures are better than budgeted figure
- e.g. costs lower than expected
- e.g. revenue/ profits higher than expected
Adverse Variances
- actual figures worse than budget figure
- e.g. costs higher than expected
- e.g. revenue/ profits lower than expected
Why is cash flow important?
- cash flow is dynamic and unpredictable part of life for most businesses
- cash flow problems are the main reason why a business fails
Cash Inflows Examples
- cash sales
- sale of fixed asset
- interest on bank balances
- grants
- loans from bank
Cash Outflow Examples
- payments to suppliers
- wages and salaries
- tax on profits
- dividends paid to shareholders
- repayment of loans
What is cash flow problem?
when a business does not have enough cash to be able to pay its liabilities
Main causes of Cash Flow Problems
- low profits or (worse) losses
- excess inventories held
- allowing customers too long to pay
- seasonal demand
- unexpected changes in the business
Managing Working Capital
- inventories
- debtors
- creditors
Managing Amounts Owed by Customers
- credit control
- selling off debts to debt factors
- cash discounts for prompt payment
What is Debt Factoring?
- the selling of debtors (money owned to the business) to a third party
- this generates cash
- it guarantees the firm a percentage of money owed to it
- cost involved in factoring can be high
What is credit control?
- establishing credit limits for new customers
- credit checking new and existing customers
- setting realistic credit limits
- determine appropriate terms and conditions for credit
Long-Term Sources of Finance
- finances the whole business over many years
e.g. - share capital
- retained profits
- venture capital
- mortgages
- long-term bank loans
Medium-Term Sources of Finance
- finances major projects or assets with a long-life
e.g. - bank loans
- leasing
- hire purchase
- government grants
Short-Term Sources of Finance
- finances day-to-day trading of the business
e.g. - bank overdraft
- trade creditors
- factoring
- short-term bank loans
Main Internal Sources of finance for a Start Up Business
- founder finance
- retained profits
- friends and family
Main External Sources of finance for a Start Up Business
- bank loan
- bank overdraft
- loans and grants
Main Internal Sources of finance for an Established Business
- retained profits
- working capital
- asset disposal
Main External Sources of finance for an Established Business
- issue shares
- bank loan/ overdraft
- debentures
- suppliers
Ways of Raising Loan Capital
- bank overdraft
- bank loan
- debentures
Bank Overdrafts
short-term finance, widely used by businesses
the bank lets the business ‘owe its money’ when the bank balance goes below zero, in return for charging a high rate of interest
flexible
Bank Loans
long-term finance
good for financing investment in fixed assets
generally at a lower rate of interest that a bank overdraft has
not much flexibility
Debentures
a debenture is a form of bond or long-term loan which is issued by the company, usually with a fixed rate of interest
What is a financial objective?
a specific goal or target of relating to the financial performance, resources and structure of a business
Profit Formula
Total Revenue - Total Costs
Cash Flow Formula
Total Cash Inflows - Total Cash Outflows
How does Cash Flow differ from Profit?
timing differences
- sales to customers made on credit
- payment to suppliers
the way fixed assets are accounted for
cash flows arising from the way the business is financed
What is Business Investment?
- capital expenditure on items such as product machinery, IT systems, buildings etc.
- can also be the purchase of other businesses or brands
- investment is intended to help generate a return over more than one year
Equity
amount invested by the owners of the business
Debt
finance provided to the business by external parties
What is ratio analysis?
analysing relationships between financial data to assess the performance of a business
Gross Profit Formula
revenue - cost of sales
Gross Margin (%) Formula
gross profit/ revenue
What is operating profit?
is what is left after all the costs of a business have been taken from its revenues
Operating Profit Margin Formula
operating profit/ revenues x 100
Revenue Formula
volume sold x average selling price
Two main ways for a business to increase revenues
- increase quantity sold
- achieve higher selling price
Variable Costs
- costs which change as output varies
e.g.
raw materials
wages based on hours
Fixed Costs
- costs which do not change when output varies
e.g.
rent and rates
salaries
advertising
Total Costs (TC) Formula
fixed costs (FC) + variable costs (VC)
