Unit 3.5 Flashcards
Finance
the management of the investment needed to open, run and grow a business
External finance
investment for the business that is obtained from banks, investors and lender OUTSIDE of the business.
Internal finance
money gained from INSIDE the business, e.g. owners personal savings
Receivables
customers that owe money to the business
cash-flow management
important to a business to ensure it has enough cash to pay off it’s day-to-day expenses
Deb factoring
selling debts to other companies who will collect it on behalf of the business, quickly eliminating receivables and replacing them with cash.
Debt Factoring - Pros
- improves cash flow
- frees up finance department
- good for small businesses who don’t have the resources to case debts
Debt factoring - Cons
- lower profit figure as full amount is never achieved
- damage the reputation of the business who is seen as taking desperate measures to secure short-term finance.
- company accounts less attractive to potential investors
Overdrafts
short term lending of capital by a bank to a business
Overdraft - Pros
- quick fix method during a difficult month of sales etc.
- can be arranged quickly
- can be easily payed back
Overdraft cons
- very expensive source of finance - high interest rates
- not suitable for large amounts over a long period of time
Retained profits
profits that a business can use to reinvest back into the company.
Retained profits - Pros
- no interest
- no loss of shares or control for the owner
- business doesn’t see a rise in their levels of debt
Retained profits - Cons
- New businesses wont have access to this form of finance.
- Businesses may not have large amounts of retained profit
- opportunity cost of not being able to use the cash on other projects.
Share capital
finance raised from issuing shares in the business - external and long term method of finance
Share capital - Pros
- investors often willing to provide extra investment to help the business grow
- cost effective than a loan etc as no interest to pay back
Share capital - Cons
- investors may require lost of background info. before buying the shares
Loans
renting money from a bank
Loans - Pros
- fixed for certain length of time which will mean allow companies to plan ahead and know exactly when payments will leave their bank account.
- Don’t lose control or power within the business
- straightforward process
Loans - Cons
- Bank will charge interest on the loan
- not very flexible
- bank will ask for security on a loan which may be a house etc
Venture capital
Issuing shares to a small number of investors in return for capital to invest into the business
Venture capital - Pros
- business can gain skills of the venture capital investors and can gain links to good suppliers etc
- good for owner who have been refused a bank loan
Venture capital - Cons
- the investors look for strong business plans which can be difficult for some start-ups to produce
- typically want large % stakes in the business - the owner will lose a lot of power within the business.
Cash flow
incoming’s and outgoings of cash, representing the trading activities of the firm
cash flow forecast
prediction of he timing and amounts of cash inflows and outflow over a specific period
shows if a firm needs to borrow cash and how much they may need to borrow.
Cash inflows
Loans
Shares
Revenue from sales
Investments
Receivables
Cash outflows
Salary’s
manufacturing costs
rents
tax
loan repayments
payable’s
Opening balance
this is the amount a business has at the start of each month
Closing balance
this is the money a business has at the end of each month
Inflows
all the money coming into a business
Outflows
all the money going out of the business
Importance of cash flow
cash flow problems are the main reason businesses fail
Why create cash flow
- creates an advanced warning of cash shortages
- ensures business can pay employees and suppliers
- reassurance to investors that the business is being managed properly
Why do businesses suffer from cash flow problems?
- suppliers may have very short credit periods as new businesses don’t have a good track record for paying bills on time
- new businesses will not have cash reserves built up
Cash flow problems
- sales lower than expected
- easy to be over-optimistic about sales
- market research may have gaps
-customers not paying on time
Credit periods
affect the ability of the business to gain credit from its suppliers - the longer the credit period the later the cash flows out
Solutions to cash flow problems
- overdraft arrangements
- negotiating terms with creditors
- reviewing and rescheduling capital expenditure
Limitations of cashflow forecasting
- based on forecasts and may be inaccurate
- cannot plan for unexpected events
- Time consuming to create
Difficulties in budgeting accurately - Sales forecasting
- harder when the market experiences rapid change
- start-up firms find it hard to estimate sales and revenues
Difficulties in budgeting accurately - Costs
- unexpected costs
- depending on sales budget
- changes in external environment will impact costs (exchange rates)
Variation analysis
calculating and investing the difference between actual results and the budget
Variables can be adverse or favourable
What is a budget
A financial plan for the future concerning the revenues and costs of a business
Budgeting is a process
- process by which financial control is exercised in a business
- budgeting for revenues and costs are prepared in advance then compared with actual results to show any variances
Budgeting uses in management
- establish priorities and set targets
- Assign responsibilities
- motivate staff
- forecast outcomes
- delegate without loss of control
Principles of good budgeting
- managerial responsibilities are clearly defined
- performance is monitored against the budget
- unaccounted for variances are investigated
Favourable variances
actual figures are better than the budgeted figures
Adverse variances
Actual figures are worse than budgeted figure
Causes of Favourable variances
- stronger market demand than expected
- cautious sales and cost assumptions
- competitor weaknesses
- higher productivity or efficiency than expected
Causes of Adverse variances
- Unexpected events lead to unbudgeted costs
- over-spends by budget holders
- sales forecasts prove over-optimistic
- Market conditions mean selling prices are lower than budget
Break-even point
where total revenue from sales is exactly the same as total costs
Level of output where total costs and total revenue are the same = break-even output
Contribution
amount of money left over after variable costs are subtracted from the selling price of each output
Effect of break-even on changes in costs and prices - fixed costs
fixed costs increase, business will have to produce more to break even
Effect of break-even on changes in costs and prices - Variable costs
variable costs increase, total costs will rise with level of output meaning the business will have to produce more to break-even
Effect of break-even on changes in costs and prices - changes in price
price increases then total revenue function will be steeper as revenue will be higher at every level of output meaning the businesses break-even will be at a lower output.
Margin of safety
How much output or sales level can fall before a business reaches it’s breakeven output
Operational objectives
short-term goals of the business
Operational objectives - Costs
mass market goods = aim to produce goods and services at the lowest possible costs = lower prices for consumers
Operational objectives - quality
business aims to create a product or service which fulfills the customers needs - good quality goods and services will give the business a competitive advantage
Operational objectives - Speed of response
could be lead time ( time from customer order to the moment they receive the goods - quick responses mean customer satisfaction and reduced costs from returns and complaints
Operational objectives - Flexibility
business needs to be able to change the products or services it offers to meet consumer trends.
Product flexibility = ability to change products
Volume flexibility = ability to change number of products produced
Operational objectives - dependability
business needs to produce goods and services that meet consumer laws ( below )
- be able to make deliveries on time
- dependability is linked to reputation and customer loyalty
Operational objectives - Environmental objectives
Businesses now have CSR and environmental policies which will help them to reduce costs - some may also use environmental objectives as a USP
May involve…
- Energy use
- Water consumption
- Noise polloution
Operational objectives - Added value
any process that gives more perceived value to the customer
Internal influences on operational objectives
- Human resources - availability of skilled workforce
- Production - capacity to meet changes in demand
- Finances - size of operational budgets
- Marketing - promotional activity may increase demand
- Mission statement - feeds into the corporate objectives
Income statement
shows the trading position of the business which is used to calculate gross profit
Balance sheet = snapshot of a business’s net worth at that particular moment - AKA the statement of financial position
Cost of goods sold
Opening inventory = value of the inventory within a business at the start of a financial year
Closing inventory - value of inventory at the end of a financial year
Two approaches of measuring profit
Profit in ABSLOOUTE terms - the value of profits earned - e.g. £50,000 profit made in the year
Profit in RELATIVE terms - profit earned as a proportion of sales achieved or investment made - e.g. £50,000 profit made from £500,000 of sales equalling a 10% profit margin
Ratio analysis
analysing relationships between financial data to assess the performance of a business
what do profitability ratios provide?
- Is the business making a profit
- how efficient is the business at turning revenues into profit
- is the profit enough to justify investment in the business?
- How does the profit achieved compare with the rest of the industry
Operating profit
what is left after all the costs of a business have been taken from it’s revenues
What does operating profit margin tell us?
- how effectively a business turns its sales into profit
- How efficiently a business is run
- whether a business can ‘add value’ during the production process
Internal influences on finance
- availability of resources
- mission statement
- corporate objectives
- owners personal objectives
External Influences on finance
- actions of competitors
- economic climate
- availability of external sources of finance
- market conditions
