Unit 5 Flashcards
What are financial objectives?
Monetary targets that a business aims to meet within a certain amount of time
-Return on investment
-Capital structure
-Revenue
-Costs
-Profit
-Cash flow
What’s the return on investment?
how much the business makes back from their initial investment
What’s the equation for Return on investment?
(operating profit/capital invested) X 100
What’s long term funding?
amount of capital that’s been invested in a business and will stay in the business for over a year.
Sources of long term funding
-Equity
-Debt
What is gearing?
The proportion of long term funding that is debt
What’s the equation for gearing?
(Debt/long term funding) X 100
What’s a revenue objective?
targets set for the amount of money coming into a business from sales in a set period of time.
What’s a cost objective?
limits set for amount of money to be spent on expenditure in a set period of time.
What’s the equation for profit?
Revenue-Total costs
What’s a profit objective?
Targets sets for the amount of surplus to be achieved in a set period of time
Equation for sales revenue
Quantity sold X selling price
Equation for gross profit
Sales revenue-cost of sales
What are expenses?
All other costs associated with the trading of the business
Equation for Operating profit
gross profit-expenses
Equation for Profit for the year
Operating profit-interest and taxation
What’s cash flow?
The movement of money into and out of a business/
what’s the difference between cash and profit?
Cash is the physical existence of money within business
Profit is in financial records when revenue is greater than costs
External influences on financial objectives
-Competitors
-Consumers
-Economic conditions
-External environment
Internal influences on financial objectives
-Corporate and other functional objectives
-Characteristics of the firm
-Relationship between owners and directors
-Public or private sector
What are budgets?
Budgets are forecast of plans for future finances of a business
Examples of a budget
-Income
-Expenditure
-Profit
What is an expenditure budget?
A limit on the amount to be spent in a given period of time
What’s a profit budget?
A target set for the surplus between income and expenditure in a given period of time.
What are the problems with setting a budget?
-Dependent upon prediction and forecasts
-Costs are subject to change
-Actions of competitors are unknown
-Managers may lack experience
-Bias
-Takes time and effort
What’s variance?
The difference between actual income, expenditure or profit and figure that had been budgeted
What’s adverse variance?
Variance that’s bad for business
-expenditure higher than budget
-Income lower than budget
What’s a favourable variance?
Variance that’s good for a business
-Expenditure lower than budget
-Income higher than budget
-Profit higher than budget
What are possible causes of variances?
-Action of competitors
-Action of suppliers
-Changes in economy
-Internal inefficiency
-Internal decision making
How can variance inform decision making?
-Change budgets
-Staff training
-Reward staff
-Change suppliers
-Reallocate budgets
-New marketing tactics
-Review product portfolio
Advantages of budgets
-Provides a quantifiable target at which outcomes can be measured
-Informs decision making
-Motivates budget holders due to increased responsibility
Disadvantages of budgets
-Potential for conflict
-May be restrictive
-Time consuming
What’s a cash flow forecast?
A statement that predicts cash inflows and outflows in the future
What’s a cash flow statement?
A statement that shows what happened to cash inflows and outflows
Whats the equation for net cash flow?
Cash inflows - Cash outflows
Whats the equation for net cash flow?
Cash inflows - Cash outflows
What are cash flow forecasts useful for?
-Identify the timing and significance of any potential shortfalls
-Identify possible corrective action
-Help secure finance from investors or the bank
-Give confidence about short term survival
-Provide a guide against which to measure actual cash flow
What factors affect cash flow
-Transaction types (sales, purchases, payment terms)
-Timings of cash flows (Seasonal sales, Timings of payments in and out)
-Nature of the business (start-up capital and costs, time taken from input to output, stock holdings)
What might a business do if cash inflows are too slow?
-offering discounts for early payments
-Penalties for late payments
-Chase customers for payment
What’s a receivable?
Money a business is owed from customers
What might a business do if cash outflows are too quick?
Negotiating longer payment terms from suppliers
What’s a payable?
Money a business owes to suppliers
What are the causes of cash flow problems
-Credit sales
-Overtrading
-Internal management
-Seasonality
-Unexpected events
How can a business improve cash flow?
-Increasing the volume of the inflow of cash
-Speeding up the timing of the inflow of cash
-Reducing the volume of outflows
-Slowing down the timing of outflow of cash
How can a business improve cash inflows?
-Overdrafts
-Short term loan
-Debt factoring-selling a business’ debts
-Selling assets
-Sale and leaseback-turing an asset into cash while still being able to use it through a lease agreement
-Cash payments from customers
-Credit control-process of chasing payments from debtors
How can a business improve outflows?
-Delaying payment to suppliers
-Stock management
-Reduce overhead spending
What are the difficulties fo improving cash flow?
-Damage to firm’s reputation
-Potential loss of customers
-Administrative costs and time
-Loss of discounts or need to offer discounts
-May affect profitability
What is break even?
The point at which the business isn’t making a profit or loss
What’s break even output?
The number of items that must be sold to reach break even point
What’s the equation for contribution per unit?
Selling price per unit - variable cost per unit
Whats the equation for contribution?
Selling price - variable costs
What’s the equation for total contribution?
Total sales revenue - total variable costs
What’s the equation for break even point?
Fixed costs/contribution per unit
What’s margin of safety?
How much actual output is above break even level of output
What are the strengths of break even?
-Allows business to know the minimum number of sales before making a profit
-Calculate the level of profit or loss at different levels
-Predict outcomes of changing variables
-Provides a target
-Integral for business planning
-Aids decision making
What are the weaknesses of break even?
-Based on predicted costs and revenues
-Fixed costs may vary in the long run
-Ignores changes in variable costs or selling price
-Only indicates the number of sales needed
What does profitability mean?
Measures the financial performance of a business by comparing profits achieved to a second variable
What are the 3 profitability ratios in Finance?
-Gross profit margin
-Operating profit margin
-Profit for the year margin
What’s the equation for gross profit margin (GPM)?
(Gross profit/sales revenue) X 100
What’s the equation for operating profit margin (OPM)?
(Operating profit/sales revenue) X 100
What’s the equation for profit for the year margin?
(Profit for the year/sales revenue) X 100
How can business improve profits/profitability?
-Sell product for a higher price
-Sell more at the current price
-Sell the same at the same price but reduce costs
What’s the difference between internal and external sources of finance?
Internal-money from within the business
External-money from outside the business
What are some examples of sources for finance?
-Debt factoring
-Overdrafts
-Retained profits
-Share capital
-Loan
-Venture capital
What’s debt factoring?
The process of selling the debts owed to a business to a financial institution
The business receives funds immediately however at a reduced rate
Pros of debt factoring
-Receives large amount of debt immediately
-Good source of short term finance to address cash flow problems
-Debts are chased by experts saving managers time
-Reduces the risk of bad debts
Disadvantages of debt factoring
-Reduces profitability of the firm
-May damage the reputation of the firm as they’re seen to be in need of short term finance
What’s an overdraft?
The ability to overspend on an account up to an agreed sum
(bank account goes below zero or minus numbers)
What are the pros of overdrafts?
-Only borrowed when required (flexible)
-Only pay for the money borrowed
-Quick and easy to arrange
-No charges for paying off the overdraft
What are the disadvantages of overdrafts
-The bank can call it any time
-Only available from your current bank account
-Interest payments tend to be variable making it harder to budget
-Banks may secure the overdraft against business’ assets
What’s retained profit?
Profit kept within a business
Pros of retained profit
-Avoids interest payments
-Doesn’t dilute the business ownership
Cons of retained profit
-Only an option if the profits exist within the business
-May cause shareholder dissatisfaction
-Reduces the security blanket of keeping retained profit
What’s share capital?
Finance raised from the sales of shares
Pros of share capital
-Only need to pay dividends if a profit is being made
-Possible to raise large amounts of finance
-No interest payment
Cons of share capital
-Loss of ownership as shareholders are part owners
-Potential risk of loss of control for a PLC
-Complex and costly process if issuing shares
What’s a loan?
A set amount of money provided for a specific purpose to be repaid later with interest
Pros of loans
-Quick and easy to secure
-Fixed interest rates allow firms to budget
-Improved cash flow
-The borrower retains ownership of the company
Cons of loans
-Interest must be paid regardless of financial -performance
-A highly geared firm may be seen as high risk
-Collateral is normally provided
-Often more expensive than other forms of finance
-Can be charged a penalty for early payment
What’s venture capital
Investment from an established business into another business in return for a percentage equity in the business
Pros of venture capital
-Potential for large sums of money
-Expertise to help the business
-Makes it easier to attract other sources of finance
-Provides the required capital for expansion
Cons of venture capital
-Long and complex process
-Expert financial projections are likely to be required
-Initially expensive for the firm
Partial loss of ownership
-Risk of conflict or perceived interference
What’s crowdfunding?
Involves raising finance from a large number of people each investing different, often small amounts of money
