Topic 5 Finance Flashcards
What is sales revenue
The value of total sales made by a business within a period
What are costs
The expenses incurred by a firm in producing and selling its products, such as wages and raw materials
What is profit
It is made when sales revenue exceeds total costs
Why is profit important (3)
- it provides a measure of success
- it is a source of capital
- it attracts further funds from investors enticed by a high return on their investment (shares and dividends)
Formula for sales revenue
Quality sold X selling price
How can a firm increase its revenue? What does it depend on
It depends on price elasticity
If price goes up and demand does not change much, what is this called
Price inelastic
If the price goes down and demand increases, what is this known as
Price elastic
Why is cost information a very important element in managing a business (2)
- Can the price customers are willing to pay cover the costs of production?
- How do actual costs compare to budgeted costs? Is the business working costs efficiently?
What are fixed costs
Costs that do not change directly with the level of output. They exist even if the business does not produce any goods
What are variable costs
Costs that can vary directly with the level of output. The more a business produces, the higher the cost would be
Total costs formula
Fixed costs +total variable costs
Profit formula
Total revenue - total costs
Gross Profit formula
Sales - cost of sales
Net profit formula
Gross profit - expenses
Gross profit= sales - cost of sales
Profit for the year formula
Net profit - all other costs such as tax etc
Net profit = gross profit - expenses
Gross profit= sales - cost of sales
Profit margin formula
Profit
——- X 100
Sales revenue
Price elasticity of demand formula
% change in demand
_______________________
% change in price
How to increase profit
-variable costs? (2)
Reduce variable costs per unit
- bargain with suppliers for cheaper deals
- improve productive efficiency to increase productivity and lower wastage
How to increase profit
-fixed costs?
Increase output
Factors that affect the level of demand (5)
- price and incomes
- tastes and fashions
- competitor actions
- seasonal changes
- changing technology
What is turnover
Revenue
What are the 2 ways of increasing revenues
-increase quantity sold e.g. by cutting the price offering a volume related incentive (2 for 1)
-achieve a higher selling price
•best to add value rather than simply increase price
Why are tracking costs important (3)
- it drains away profit
- main cause of cash flow problems
- changes as output or activity of business changes
What is profit (4)
- a measure of business success
- a motivating factor and incentive
- a return on investment
- reward for taking risks
What is profitability
A relative measure- comparing profits to another variable e.g. sales revenue
If there is a high added value, what does this suggest
A high added value and a strong brand
How can gross profit margin be managed (3)
- increase added value- by having the advantage of economies of scale
- go to different (maybe cheaper) suppliers, except without affecting quality
- increase sales through: increased price, promotion, we want the good to price inelastic so we don’t lose a lot of customers
How to improve operating profit margin (net profit)
- increase selling price
- decrease costs (both direct and overheads)
How can overheads be reduced (6)
- moving business to a cheaper country
- lose staff, make redundant or cut their hours
- machines to place workers
- change suppliers
- reduce wastage of electricity etc
- outsourcing- get other people to do advertising etc
How may a business have a low net profit margin
Their added value may be very low
Internal influences on financial objectives (3)
- ambitions of the leader
- finance
- operations
External influences on financial objectives
- competitive environment
- economic environment
- government
Ethical environmental influences on financial objectives (4)
- interest in the environment
- bargaining with suppliers
- taxation
- public imagine
Contribution formula
Selling price - variable cost per unit
What does all the contribution from all items sold pay towards the for the business
Fixed costs
Once enough products have been sold to make enough money to pay the fixed costs, the contribution from each item is
Profit
Total contribution formula (2)
Total revenue - total variable costs
Contribution per u it X number of units sold
If the total contribution EXCEEDS the fixed costs, the business is making a …
Profit
When will a firm break even
When total revenue = total costs
If the FIXED costs exceed the total contribution, the business is making a …
Loss
Factors affecting break even output (3)
- changes in selling price
- changes to variable costs
- changes to fixed costs
Strengths of break even analysis (4) -what does it focus on -what does it help -what does MOS calculation show -what does it illustrate
- focuses on what output is required before a business reaches profitability
- helps management and finance providers better understand the viability and risk of a business or business idea
- margin of safety calculation shows how much sales forecast can improve over-optimistic before losses are incurred
- illustrates the importance of keeping fixed costs down to a min
Limitations of break even analysis
- what are the assumptions and give an example
- what are unlikely
- what foes not always stay the same
- what does BE only work for
- what may increase
- unrealistic assumptions1 products may not be sold at the same price at different levels of output
- sales are unlikely to be same as output-there may be build up of stock or wasted output
- variable costs do not always stay the same
- only works for one product
- fixed costs could change e.g. you may need new workers etc
What 2 things does a business need to consider before increasing price
- price elasticity (price inelastic because you do not want to lose customers)
- level of competition
An advantage of increasing your price for BE
You do not have to sell as many products/ services to BE (reduces BE output)
What does contribution look at
-and what is it used to calculate
The profit made on each product- it is used in calculating how many items need to be sold to cover all the business’ total costs
What is margin of safety
The difference between actual output and breakeven output
What benefits does a cash flow forecast provide (3)
- advanced warning of cash shortages
- making sure tue business can pay suppliers
- spot problems with customer payments
what is cash flow
The flow of money INTO and OUT of a business in a given time period
What is cash flow forecasting
Estimating when cash inflows and outflows will occur and how much they will be
Importance of cash flow management
Cash position
Current and future cash position can be continually monitored
Importance of cash flow management
Cash needs
Cash needs and availability can be shown on a cash flow forecast
Importance of cash flow management
Bills
Bills must be paid by cash
Examples of cash inflows (4)
- cash sales (revenue)
- receipts from trade customers
- sale of spare assets
- investment of share capital
Examples of cash outflows (4)
- payment of wages and salaries
- buying equipment and supplies
- interest on bank loan or overdraft
- payment of dividends
What are payables (cash flow related)
Money owed to suppliers by a business (when goods have been bought on credit)
What are receivables
Money owed to a business by customers who have bought goods on credit
Total inflows =
All up all cash received
Total outflows =
All up all payments made
Net cash flow =
Total inflow - total outflow
Opening balance =
Amount of cash in bank at the start of the month
For an existing business, what is the opening balance
The closing balance of the previous month
Closing balance =
Net cash flow + opening balance
What causes cash flow problems?
- low …
- increased …
- buying …
- late…
- unexpected …
- over…
- capacity
- low sales
- increased costs outside of the business’ control
- buying machines or equipment
- late payments
- unexpected costs
- overtrading
- too much spare capacity (FC are too high e.g. if u have extra staff to look after ur extra stock)
How can we improve cash flow
- lease…
- outflows
- suppliers
- shares
- price
- debt
- credit
- stock
- leaseback
- reduce outflows
- negotiate with suppliers (or alternative suppliers)
- sell more shares (at expense of losing control of business)
- change price
- debt factoring
- credit control with customers
- hold less stock
What are the 4 ways to analyse cash flow forecasts
- closing and opening balance
- plot trends
- timings of payments and receivables
- net cash flows
- look at closing balances and compare them to the opening balance figure
- use monthly closing balances to plot trends- there may be short term problems due to seasonality but a recovery may be apparent
- look at the timings of payments and receipts. How long do customers have to pay? How long is the credit period?
- look at the net cash flows. Are you continually spending more than you are receiving?
