Unit 5 Flashcards
types of profit (not on it)
gross profit: indication of financial performance by deducting direct costs
operating profit: all trading activities minus the costs associated
profit for the year: measure of all profits
income statement
records a business’s sales rev over trading period + all relevant costs incurred as well as the business’s profit or loss
direct costs
costs allocated to a particular product or area of the business eg raw materials
indirect costs
costs related to all aspects of business’s activities eg maintenance costs
investment
purchase of assets eg machinery or property that will be used for a considerable amount of time
What are the negatives of revenue objectives? (not on it)
Don’t necessarily increase a business’s profits
Revenue objectives which entail reducing prices to increase revenue can be risky as competitor may respond + reduce prices
Capital expenditure
Spending undertaken by businesses to purchase non currents assets eg vehicles. Another term for investment
Return on investment
= profit from the investment / capital invested in the project x 100
(High fig preferable)
Capital structure (not on it)
Refers to the way in which a business has raised the capital it requires to purchase assets
two parts : debt + equity
What different types of budgets are there?
- revenue or earnings -> includes expected level of sales + likely the selling price of the product
- Expenditure -> essential for the process of production
- Profit -> important for managers + of interest of many of businesses stakeholders
Favourable vs adverse variance
Favourable when the different between the actual + budgeted figs will result in the business enjoying higher profits than show in the budget
Adverse when the difference between the figs in the budget + actual figures will lead to firms profits being lower than planned
What are the reasons for setting budgets?
- helps to gain investment or finance -> banks + potential investors will want to see accurate budgets + business plans
- Financial control
- Monitoring + review -> can establish priorities
What are the benefits in budgeting?
- provide direction -> motivate staff
- SMART objectives -> measure performance against
- Improve efficiency by eliminating waste + over spending
- Encourage careful planning -> improves performance -> gives some accountability
Cash flow forecasts
State the inflows + outflows of cash that the mangers of a business expect over some future period
- used to make sure always have enough money to pay suppliers + employees as they can arrange loan or overdraft in time
- they are shown to banks to try get loans
Why do managers forecast the cash flow?
- to support applications for loans -> banks more likely to lend if they have evidence
- To help avoid unexpected cash flow crises -> can help to ensure the business does not suffer from periods where they are short of cash + unable to pay debts -> CFF can identify times when this might be the case, managers prepare
What is meant by a cash flow problem?
When a business does not have enough cash to be able to pay its liabilities
Breakeven output =
fixed costs/ contribution per unit
The level of output or production at which totals cost exactly equal revenue from sales
Contribution
The difference between revenue + variable costs
what the business needs to achieve in order to first cover its fixed costs + thereafter make a profit
To calculate the break even point what does a manager need?
- the selling price of the product
- The variable cost of producing a single unit of that product
- fixed costs associated w product
What assumptions do you have to make when doing break even analysis?
- selling price per unit stays the same
- Variable costs vary in direct proportion to output
- All output is sold
- Fixed costs do not vary with out put
Profit margin
A ratio that expresses a business’s profits as a % of its revenue over some trading period
eg Gross profit margin
= gross profit / revenue x 100
Operating profit margin
= operating profit / sales revenue x 100
Profit for the year margin
= profit for the year / revenue x 100
Why do businesses need short term finances?
pay outstanding bills
Overcome temp cash shortages
What are internal and external sources of short term finance?
retained profits + overdrafts, debt factoring
What are internal and external sources of long term finance?
retained profits, sales of assets + bank loans, debentures, venture capital + share capital
Positives and negatives of using retained profit?
+ avoid pay interest on a loan -> avoids heavy interest charges
+ Avoid need for a company to sell further shares, enabling shareholders to retain control
- opportunity costs -> lose out from not using elsewhere
- Shareholders unhappy as receive lower dividend
Benefits of debt factoring?
Negatives?
+ immediate cash provided by the factor means that the firm is likely to have lower overdraft requirements + will pay less interest
+ Factoring means businesses receive the cash from their sales more quickly
- reduce or even eliminate business’s profit margin, if it is small
- Customers may be aware that if debts are factored -> lose faith in supplier
Share capital is source of finance for both Ltd and Plc, in the uk why is sit easier to sell shares for a plc?
- sell on stock exchange. Efficient international market which brings together buyers + sellers + sets prices
- Plc do not need permission of other shareholders to sell shares + existing shareholders can sell freely
What are factors that contribute to cash flow difficulties?
LOAPI
- lack of planning by managers
- Over trading
- Allowing too much trade credit
- Poor credit control
- Inaccurate cash flow forecasting
Methods of improving cash flow problems?
INODA
- Improved control of working capital
- Negotiate improved terms for trade credit
- Offer less trade credit
- Debt factoring
- Arrange short term borrowing
Methods to improve profits:
- Reduce costs of production but may result in lower quality
- Increase prices -> may result in customers looking for alternative options
- Improve the business’s efficiency
Methods of improving cash flow and the costs associated:
- Improved control of working capital -> employment of additional staff -> will increase costs
- Negotiate improved terms for trade credit -> difficult for a firm w poor payment record to achieve
- Offer less trade credit -> customers may move to other businesses offering more favourable trade credit terms. Prices may be lowered in compensation
what is debt?
finance provided to the business by external parties eg bank loans
what is equity?
amount invested by the owners of the business eg share capital
bank loans
medium term, fixed period, rate of interest is fixed, good for assets eg machinery
+ lower interest than bank overdraft
+ no dividends or control given away
- start ups + small businesses often excluded
- repayments can be difficult if cash isn’t coming in quickly enough
bank overdraft
short term finance, helps businesses handle seasonal fluctuations in cash flow
+ flexible
+ only pay interest on what they use
- can be withdrawn at short notice
- charge high rates of interest, unsuitable for LT
factoring
short term finance, a business can raise cash by selling their invoices to a third party at a discount
+ receivables turned into cash quickly
- high cost associated (discount)
- customers may feel relationship has changed
total contribution =
total revenues less total variable costs
contribution per unit x no. of units sold
contribution per unit =
selling price per unit less variable costs per unit
financial objectives (not on it)
revenue, cost, profit
set by finance ministers, consistent t w functional objectives
+ can improve co-ordination between teams, acts as a focus for decision making + allows shareholders to judge investments
capital structure (not on it)
the way a business raises capital to purchase assets
objectives -> set a debt to equity ratio or to decrease proportion of debt in their LT funding
internal factors influencing objectives (not on it)
- overall objectives
- status of the business
- other functions
external factors influencing objectives (not on it)
competitors, economy, shareholders
Gross profit = (not on it)
sales rev - cost of sales
operating profit = (not on it)
sales rev - cost of sales - operating expense
profit for the year =(not on it)
operating profit + other profit - net finance cost - tax
budgeting
a financial plan for future earnings + spendings
+ help to achieve targets, control costs, to review decisions
- can cause rivalry in departments, can be restrictive, time consuming
what factors cause variance?
external eg competitor behaviour, changes in economy
internal eg efficiency levels, over or underestimate, selling price
small variances
aren’t a problem eg favourable ones can motivate staff
large variance
can demotivate either task is impossible (adverse) or don’t see the need to worker harder (favourable)
break-even output is
the level of sales a business needs to cover its costs
break-even point is
when costs = revenue
when costs > revenue = business is making a loss
when costs < revenue = business is making a profit
margin of safety =
actual output - breakeven output -> allows the business to make decision
venture capital
funding from professional inventors who provide expertise but take a % of the business
share capital
selling shares either on stock market or within the business
+ doesn’t need to be paid back
- expect dividends, less control
working capital
day to day running costs
creditors
people who are owed money
payables
money the business owes
debtors
people who owe the business money
Strengths of breakeven analysis
- focuses on what output is required before a business reaches profitability
- Helps management better understand the risks of the idea
- MOS shows how sales forecast can prove over optimistic before losses are incurred
Limitations of breakeven analysis
- unrealistic assumptions; products not sold at same price at different levels of output
- sales are unlikely to be same as output
- planning aid rather than decision making tool
- most businesses sell more than one product
What is credit control
Establishing credit limits for new customers, credit checking new + existing customers
