Unit 3 - Business Finance Flashcards
Need for funds
- Short-term needs - e.g. day-to-day costs, wages, bills, components
- Long-term needs - e.g. property, machinery
- Start-up capital - funs needed to start the business - often ‘one-off’ purchases
- Expansion - need finance to expand to meet more orders, make new products, branch into other markets & diversify
Internal sources of funding
- Finances raised from inside the business
- Personal savings - Owner contributes to finances from personal means
- Retained profit - profit that is not returned to the owners - cheap source with no interest, dividends or administration, relatively flexible but profit can’t be returned to the owners and owners might object
- Selling assets - can sell unwanted assets to raise finances
External sources of funding
- Finances raised from outside the business
- Bank Overdraft - Business can spend more money than it has with a limit from the bank - simple & flexible but has interest and can call in owed money at any time
- Trade payables - business can buy resources and pay back at a later date - can raise money in between but can be bad because supplier encourage early payment with discounts, cost of goods is often higher with credit, delayed payment can upset suppliers
- Credit cards - convenient, flexible, can avoid interest, high interest rated if money is not paid back
- Loan capital - fixed agreement between a business and a bank - amount borrowed and interest must be paid back in regular installments - it is known what has to be paid every month
- Unsecured bank loans - bank lends money without the security of having a claim on your assets if you don’t pay it back - higher interest rates than secured loans and are harder to find
- Mortgages - a long-term loan where the borrower has to use land or property as security - lower interest rates and can be taken out up to 25 years
- Debenture - debenture holders are creditors of a company, debenture holders entitled to a fixed rate of return but no voting rights and must be repaid on a set date
- Hire purchase - business makes a down payment, remaining fee paid in monthly installments, goods bought don’t legally belong to buyer until very last installment paid, goods can be repossessed if buyer fails, can be short or long term - usually more expensive than a bank loan
- Share capital - sale of shares - can raise a lot of money - rights issue can occur - discount to existing shareholders - interest avoided but shareholders expect dividends - cost of administration in selling shares
- Venture capital - getting investments from investors - usually take a stake and hence profit, hard to find a suitable investor with similar views, sharing profits
- Crowd funding - Businesses seeking finance online from the public to invest
Importance of cash
- To pay suppliers, overheads & employees
- To prevent business failure
Difference in cash and profit
- Amount of cash at the end of a period is different to profit since cash balance at the start of the year was not likely zero
- Purchases on fixed assets reduce cash balances but no profit
- Owners can put cash into the business which doesn’t affect profit
- Profit can be greater than cash with trade credit if money is owned but receiving cash at the beginning of a trading period can increase cash but not profit
Cash inflows
- Money entering the business
Cash outflows
Money going out of the business
Net cash flow
Difference in cash inflows and cash outflows
Cash flow forecast
Financial document that shows the expected cash inflows and outflows over a future period
Importance of cash flow forecasts
- Identifying cash shortages
- Supporting applications for funding
- Help when planning the business
- Monitoring the cash flow
How production generates costs
- Fixed costs - costs that remain the same regardless of the level of output e.g. rent, advertising
- Variable costs = production costs that change when the level of output changed - more production = more cost
Total cost equation
Fixed costs + Variable costs
Average cost equation
Total cost ÷ Quantity produced
Total revenue def
Money generated from the sale of output
Total revenue equation
Price x Quantity
Profit equation
Total revenue - Total cost
Break-even point def
The level of output where total costs and total revenue are exactly the same - neither a profit nor a loss is made
Break-even point equation
Fixed costs ÷ (Selling price - Variable cost per unit)
Margin of safety
The amount of output available to be sold above the break-even point where the business makes a profit
Break-even chart
A gray that shows total cost and total revenue - the break-even point is where the total cost and total revenue intersect
Limitations of a break-even chart
- TC & TR shown as straight lines - may not be straight in practice e.g. discounts on large orders
- Assumes all of output is sold and no stocks are held - firms usually hold stock for change in demand - can also stockpile if they can’t sell their product
- Accuracy of the graph depends on the quality and accuracy of the data used
Statement of comprehensive income
A financial document showing a firm’s income and expenditure in a particular time period
Function of statement of comprehensive income
Calculates profit at the end of year
Gross profit equation
Revenue - cost of sales
Operating profit equation
Gross profit - expenses
Profit for the year equation
Operating profit - cost of finance
- Structure of a statement of comprehensive income
- Revenue - money made from sales
- Cost of sales - costs for making products, wages, suppliers, inventory - anything associated with the delivery of the service
- Gross profit - revenue - cost of sales
- Administrative expenses - general overheads
- Other operating expenses - non-administrative expenses, can be irregular
- Selling expenses - expenses related to selling products e.g. commission & advertising
- Operating profit - gross profit - expenses (administrative and other)
- Finance costs - interest on borrowing money - can also be income e.g. receiving money on interest
- Profit for the year - operating profit - cost of finance
- Profit for the year after tax - money left over for the business after all expenses (including tax)
Use of statement of comprehensive income
- Investment decisions - can use to decided how much money to invest
- Cost analysis - shows how costs change over the year and can help reduce costs
- Basis for future forecasts - can be used to make future forecasts to investors/shareholders
- Making comparisons - Investors can use these statements to decide where to invest
Statement of financial position
- Summary at a point in time of business assets, liabilities and capital (can be called a balance sheet)
Assets
- Resources used or owned by a business e.g. cash, stock, machinery
Liabilities
- Debts of the business which provide a source of funds
Capital
Finance provided by the owners of the business
Features/structure of a statement of financial position
- Non-current assets
- Current assets
- Current liabilities
- Net current assets
- Non-current liabilities
- Net assets
- Shareholder’s Equity
Non-current assets
- Assets that last more than one year
Current assets
- Assets that are likely to be changed into cash within a year
Liquidity
- Ease or speed with which assets can be sold for cash e.g. trade receivables
Current liabilities
- Business debts which must be repaid within 12 months e.g. trade payables & tax
Net current assets
- Current assets - current liabilities (aka working capital)
Non-current liabilities
Money owed where repayment is not due for more than one year e.g. mortgages
Net assets
- Net current assets + non-current assets - non-current liabilities
Shareholder’s equity
- All the money owed to the owners
- Divided into:
- Share capital - amount of money shareholders put into the business
- Retained profit - amount of profit kept in the business - belongs to shareholders but likely won’t be returned
- Other reserves - any other amounts owing to shareholders not listed in other two categories
Profitability ratios
- Measure the performance of the business and focus on profit, revenue and amount invested in
Liquidity ratios
- Measure of how easily a business can pay its short-term debts e.g. wages or suppliers
Gross profit margin equation
- Gross profit ÷ Revenue (x100)
Operating profit margin equation
- Operating profit ÷ Revenue (x100)
Mark-up equation
- Profit per item ÷ Cost per item (x100)
- Current ratio equation
- Current assets ÷ Current liabilities
Acid test ratio equation
(Current assets - inventory) ÷ Current liabilities
Return on capital employed (ROCE) equation
- Operating profit ÷ Capital employed (x100)
Use of financial document to assess performance of a business
- Managers and employees - managers can assess and compare and reflect - employees might need financial information for wage negotiations and for job security
- Owners & shareholders - owners interested - might want to meet goals - shareholders interested by dividend size
- External stakeholders - banks need financial information, suppliers want a creditworthy business, potential investors interested
Use of financial document to inform decision making
- Funding decisions - can see money available and where it can be used
- Reducing costs - can analyze costs and see where to reduce them to increase profits
- Increasing profitability - can find ways to increase profit e.g. reducing costs and raising prices
- Investment decisions - can give information to potential investors or for whether the business should invest
Other users of financial documents
- Government - gather business and financial information - helps monitor economy
- Competitors - limited company accounts made public - competitors can analyze and compare
- Media - TV & online media companies produce reports
- Auditors - accounts of limited companies checked by independent firms of accountants and registered auditors
- Registrar of companies - limited companies have to register with registrar companies - have to submit final accounts every year that are made public
