Unit 3.3 Effective Financial Management Flashcards
Some examples of cash inflows
Cash sales loans from banks grant interest on bank balance receipts from trade debtors sale of inflow share capital invested
Examples of cash outflows
Dividends paid to shareholders Payments to suppliers Payments for fixed assets Repayment of loans Wages and salaries Interest on loans and overdrafts Tax on profits
Causes of cash flow problems
Low profit or losses Too much production capacity Too much stock Allowing customers too much credit Overtrading Unexpected changes in the business Seasonal demand
Why is a low profit or loss a problem to the cash flow
Because if you don’t generate enough profit you don’t have anything to cover your cost and couldn’t pay for your liabilities.
A new business starting out.
Why does too much production capacity result in a cash flow problem
It is expensive to run a factory but if you don’t make as many products as possible in the factory it means you’re not using the production capacity to its full extent so there is less outflows.
Paying to run it but not using.
Having a factory that can make 500 but is only making 200.
Why does too much stock create cash flow problems
Because too much money is being paid for stock and it’s not generating any inflow as it is not all being sold.
Perishable items in a restaurant or in style clothing that will go out of style.
Why does allowing the customer too much credit create cash flow problems
Because your outflows are the a lot but the inflows are less because ‘buy now pay later’ creates a lot of outflows but no short term inflows.
Sofa shop - buy not pay later but they are expensive.
Why does Overtrading (growing too fast) cause cash flow problems
Because by growing your business without a guarantee you will have any customers means no guarantee of inflow to cover the growing cost of your business.
A small business tries to expand without any solid customers.
Why do unexpected changes in the business result in cash flow problems
If something happens that affects your inflow then it affects the outflow as well.
CEO dies so business isn’t run as efficiently.
Why does seasonal demands cause cash flow problems
Because it has a lot of inflows during the season but little to none the other times of the year so it is hard to cover everything for the whole year.
A Christmas shop.
Examples of how to solve cash flow problems by changing inflows
Increase sales revenue Destocking Improving cash flow from customers Bank loans Share issue Sale of assets
Examples of how to solve cash flow problems by changing outflows
Reduce orders for new materials and stock
Delay paying invoices
Lease rather than buy
How can managing stock help solve cash flow problems
- businesses should keep smaller balances (JIT)
- computerise their orders so more efficiency
- improve stock control
This all cuts down spending on stock but may leave firm vulnerable to stock out.
How does managing debtors better improve cash flow
Credit control:
- policies on how much credit allowed and repayment terms and conditions
- credit checking
- selling off debts to debt factors
- cash discounts for prompt payment
- improved record keeping
How does a bank overdraft (compared to a bank loans) help solve cash flow problems
- easy to arrange
- flexible so you can use as cash flow requires
- interest is only paid on the amount borrowed under the facility
- not secured on asset of business
But it can be withdrawn at short notice, has a high interest rate and interest varies with changes in interest rate
How can a bank loan (compared to a bank overdraft) help solve cash flow problems
- a greater certainty of funding than a bank overdraft (provided the terms of the loan are complied with)
- lower interest rate than a bank overdraft
- appropriate method of financing fixed assets
But is requires security, is harder to arrange and interest is paid on full amount out standing.
How can share issue help solve cash flow problems
Because a share in the business is sold go an individual or another business which generates income as they pay cash for their shares.
How does sale of assets help solve cash flow problems
Because selling spare or surplus assets is a way to achieve a short term boost to cash flow e.g spare Land.
But not all businesses have spare assets.
How can reducing orders help solve cash flow problems
Because if you order fewer materials from suppliers then you have less outflow. Usually done in response to a fall in sales.
How does trade creditors help solve cash flow problems
Because the amount owed to suppliers for goods supplied on credits are not yet paid for and this delayed payment means the firm can retain cash longer.
But must be careful not to damage the firms credit reputation and rating.
How does sale and leaseback help solve cash flow problems
It involves selling fixed assets then leasing them back from new owner so they get an income from selling the asset and can still use it but can only be done once.
What are variable costs
Costs that vary directly with the level of output.
Increase as sales increase.
What are fixed costs
Costs which remain the same regardless of how many products you sell/ product.
Not affected by sales e.g rent.
What are total costs
Variable costs + fixed costs
How to work out revenue
Price x quantity sold
How to work out profit
Revenue -total costs
What is the break even point
The level of output where an organisation is just starting to cover its costs. Expressed as a number of goods or services that need to be sold but not as an amount of money.
Why can break even analysis help a business make decisions about future investments
It helps them understand what their level or volume of activity needs to be in order to be profitable.
What is revenue
The total amount of money earned via sales and can be cash sales, cheque sales, debit card sales and credit sales.
What are the three methods of calculating the break even point
- a table showing the sales and costs over different levels of outputs
- a graph which charts sales and costs
- a formula used to calculate break even output
What are the headings of the table used to find the break even point
Output. Sales. Variable costs. Fixed costs. Total costs. Profits.
In the table used to calculate break even point, where does the break even occur
When total revenue = total costs
How do you construct the break even chart
- vertical axis showing values of sales and costs
- horizontal axis showing output of goods
- add fixed costs line (horizontal straight line)
- add variable cost line - plot a few points and draw a straight line
- add variable cost and fixed costs together for each level of output and draw the line
- identify the break even output - where total sales = total costs.
What is the formula to calculate break even point
Contribution (the selling price - variable costs)
What can change a break even chart
Price goes up or down
Fixed costs go up or down
Variable costs go up or down
What would happen to the break even point if the variable costs increase
It would increase
What would happen to the break even point if the variable costs fell
It would decrease
What would happen to the break even point if the fixed costs increased
It would increase
What would happen to the break even point if the fixed costs fell
It would decrease
What would happen to the break even point if the selling price increased
It would decrease
What would happen to the break even point if the selling price fell
It would increase
The two different ways of financing a business
The internal sources (within a business)
The external sources (outside a business)
What are the typical sources of financing a business
Retained profit Asset sales Share capital Overdraft Loans Bonds Trade credit
What is retained profit
Is how much percentage revenue the business is able to keep that is not being used to cover costs and can be reinvested in its core business
What are asset sales
The sale of spare equipment and assets by the business to generate income
What is share capital
The total amount of money and property a company has received for selling its shares to share holders
What is an overdraft
A source of finance that allows you to borrow money so you can draw out more than your account holds.
What is a loan
A longer term source of finance by the bank that is expected to be paid back with interest
What is a bond
A debt security and when you purchase one you are lending money to the government or another issuer and in return they will pay money back with interest when the bond comes of age.
What is trade credit
The credit extended to you by suppliers who let you buy now and pay later.
What do businesses need to think about when deciding how to finance their growth
The cost, risk and availability of the finance
Why do businesses need to think about cost when deciding a source of finance
Because they need to know if the cost of the source of finance is appropriate for the use of the finance.
The costs of trade credit, retained profit, borrowing (e.g loans) and shares
Cheap, free, has interest and dividends.
Why does a business need to think about risk when deciding their source of finance
Do they trust the suppliers? Can they pay back? What affect will it have in the future?
Why do businesses need to think about availability when deciding a source of finance
Because a sole trader can’t raise finance from share issues so the sold trader would have to use a different source of finance available to them
Why might a small business find it difficult to raise finance through new shares
They are unlikely to be listed on the stock exchange so will not be able to readily attract new investors
Why might a new business find it difficult to retain profit
They may need all their profit to help cover costs therefore having finance from retained profit would be difficult
Why might some businesses find selling their assets a bad source of finance
If the business needs all their assets they wouldn’t have any to sell to generate any finance.
Why might a business find bonds a difficult source of finance
Because if the supplier of the bonds goes bankrupt the business would lose their money.
Also if it’s the businesses bonds then they would have to repay with interest later on generating a bigger outflow.
Why might trade credit be a difficult source of finance to a business
If it’s a new supplier they may be unwilling to give trade credit to the business so they business would have to pay upfront.
What is a cash flow problem?
When a business does not have enough cash to be able to pay its liabilities
