Unit 5 Flashcards
financial objective
all types of businesses must have profit as a financial objective
key financial objectives
- Profit = targets for revenue & costs
- Cash flow
- Return on investment
- Capital structure
return on investment meaning as an objective
meaning how much profit is made from an investment?
capital structure meaning as an objective
meaning where is the capital or funding coming from?
what are the 3 types of profit?
- gross profit
- operating profit
- profit for the year
what is the equation for gross profit?
revenue - cost of sales
what is the equation for operating profit?
gross profit - expenses
what is the equation for profit of the year?
operating profit - tax
what is cashflow?
the amount of money available in the business’ bank account to pay for its day-to-day expenses
cashflow as an objective
A positive cash flow enables a business to pay their suppliers & lenders & avoid the risk of being taken to court & put into liquidation
equation for cashlow
cash inflow - cash outflow = net cashflow
equation for profit
revenue - total costs
links between profit and cashflow
- Revenues eventually turn into cash inflows
- Costs eventually turn into cash outflows
- A business with a consistently negative cash flow is unlikely to make a profit
return on investment as an objective
Return on investment measures the profit made as a % of the initial investment
equation for return of investment
(profit made from investment / cost of investment) x 100
2 main capital sources
- shareholders
- banks
capital structure as an objective
- shareholder= equity
- banks = debt
why is equity safe?
- capital obtained from the sale of shares doesn’t have to be repaid
- doesn’t make a profit no dividend is due to shareholders
why is debt dangerous?
- loan must be repaid with interest whether the business has enough cash flow or not
- bank can take court action = risk of liquidation
ideal capital structure
less than 50% of a business’ capital should come from banks
equation for gearing
(loan capital / total capital borrowed) x 100
benefits of having clear financial objectives
- Specific & measurable way of assessing success or failure
- clear targets for managers to achieve
- used to reward managers for achieving these targets (bonus payments)
- Enables shareholders to anticipate how much dividend they will receive & to compare the return on investment with other investment options
what is a budget in measuring financial performance?
financial plan for the future anticipating the revenues, costs & profit of a business
budgets
budget shows forecasted (planned) & actual figures for revenue, expenses & profit
calculating budgets
means calculating & investigating the differences between actual results & the budgeted figures
what is a variance?
is a difference between an actual & a budgeted figure
equation for variance
budgeted figure - actual figure
favourable variance
better than expected
e.g. costs lower than expected
e.g. revenue/profits higher than expected
adverse variance
worse than expected
e.g. costs higher than expected
e.g. revenue/profits lower than expected
example of an adverse variance ending in good result
higher production costs than budget (adverse variance) due to sales being significantly higher than budgeted (favourable budget)
managing cashflow
A cash flow forecast is a budget* for the cash flowing into & out of a business’ account over a period of time.
what is liquidity
Liquidity is the amount of cash available in a business’ bank account
key words in cash flow forecast
- Net cash flow
- Opening balance
- Closing balance
value of cash flow forecasts
- show a surplus of cash which could be invested or used for expansion
- show cash flow issues= will the business run out of cash?
- manage cash flow issues by taking actions: get an overdraft, a loan or change timings of cash outflows
what are receivables?q
money owed to the business by customers who haven’t paid their invoice yet (future cash inflows)
what are payables?
money the business owes to its suppliers (future cash outflows)
solving unexpected cashflow problems
- Ask for or increase an overdraft
- Apply for a short-term loan
- Debt-factoring
what is debt factoring?
when a business sells its accounts receivables to a third party at a discount, enabling companies to immediately unlock cash tied up in unpaid invoices without having to wait the usual payment terms.
pros of debt factoring
- A quick way to turn receivables into cash
- Avoids having to borrow money
- It is not a debt
- No need to chase customers for payment
cons of debt factoring
- This service has a cost (% of the receivables &/or a fee)
- Some customers may disapprove of having to deal with a debt factoring company
contribution per unit
contributes towards paying for the fixed costs
equation for contribution per unit
selling price - variable cost
total contribution
- the contribution from all the units sold
- pays for the fixed costs. Any overflow is profit
equation for total contribution
actual output x contribution per unit
what id break even?
the production level at which total revenues equal total expenses.
break even equation
fixed cost / contribution per unit
or break even equation
fixed cost / (selling price - variable cost)
what is margin of safety?
the difference between the actual output & the break even point.m
margin of safety equation
Actual output - breakeven output
comparing profitability
compare profit with sales
equation for profit margins
(Profit* / Sales revenue) x 100
assessing profit margins
- Compare the figure with previous year(s)
- Compare the figure with competitors
improving profit
- Increase sales
- Reduce fixed costs
- Reduce variable costs
how to increase sales
- Increase promotions
- Reduce price (if -1 <PED)
- Use a product life extension strategy
- Find new markets or segments
- Launch a new product
how to reduce fixed costs
- Find cheaper premises
- Reduce staff number
- Replace staff by machines
- Increase capacity utilisation
how to lower variable costs
- Find cheaper suppliers
- Find ways of achieving purchasing economies of scale (bulk buying)
internal sources of finance
- Retained profit
- Sale of asset(s)
short term external sources of finance
- Overdraft
- Trade credit
- Debt factoring
long term external sources of finance
- Bank loan
- Venture capital
- Crowdfunding
- Share capital
criteria for choosing source of finance
- available to the business? (sole trader, Ltd or Plc)
- Amount needed
- interest
- Risks
- Impact on control of the business
- Long vs short term impact
pros of selling fixed assets
- no interest
- no control given up
- quick form of cashc
cons of selling fixed assets
-finite
- risk of not receiving value and buyer
pros of overdraft
- quick and simple to organise
- bespoke to business
- no control given up
- short term debt not included in gearing ratio
cons of overdraft
- interest = costs
- bank has power to cancel overdraft
- consistent use of overdraft can damage credit rating
pros of trade credit
- simple to arrange and maintain if meet terms
- cheap form of short term finance
-no control given up
cons of trade credit
- risk of spoiling relationship with supplier if terms not met
- late fines
pros of bank loans
-keep control
- bespoke to business needs
- frequent repayments may improve credit score
cons of bank loans
- assets taken is not payed
- no flexibility
- risk credit score
- gearing increased
pros of crowdfunding
- no repayments
- exposure of business = marketing
- good feedback = large amount of investors align with business
cons of crowdfunding
- profits shared
- risk of business reputation
- limited expertise of investors
pros of venture capital
- no repayment
- reduce personal risk
- venture capitalists provide expertise
cons of venture capital
- control given
- venture capitalists looking to exit as wants money
pros of new share issue
- no interest
- if plc can raise large amount of finance
- employee incentive
cons of new share issue
- give up share of business
- dividends
- take over risk
- flotation to become plc
