Unit 5 - Finance Flashcards
what is return on investment?
ROI is a measure of a firm’s profitability and performance
return on investment (answer %)
operating profit
———————— x100
capital invested
profit equation
revenue - total costs = profit
what is a variance?
the difference between two numbers
what is an adverse variance?
an adverse variance is one that is bad
for the business
- expenditure higher than budget
- income lower than budget
- profit lower than budget
what is a favourable variance?
favourable variance is one that is good for the business
- expenditure lower than budget
- income higher than budget
- profit higher than budget
limitations of a budget
- are only as good as the data being used
- can lead to inflexibility in decision-making
- need to be changed as circumstances change
- take time to complete and manage
- can result in short term decisions to keep within the budget
what is break-even?
break-even is the point at which a business is not making a profit or a loss
- total costs must equal total revenue
contribution equation
selling price - variable costs = contribution
break even calculation
fixed Costs ÷ (sales price per unit – variable costs per unit) = break even
what is the margin of safety?
margin of safety is how much actual output is above the break-even level of output
margin of safety equation
actual output level – break-even level of output
what is gross profit margin
Gross profit margin (GPM) is a measure of a firm’s profitability by looking at the relationship between gross profit and sales revenue
if the gross profit margin is falling what might this mean
- is not managing its cost of sales effectively e.g. are the cost of raw
materials increasing? - sales are in decline
gross profit margin equation
gross profit
——————- x100
sales revenue
what is operating profit margin
operating profit margin (OPM) is a measure of a firm’s profitability by
looking at the relationship between net profit and sales revenue
what does it mean if operating profit margin is falling
- is not managing its expenses effectively e.g. wages are increasing or
overheads are going up - sales are in decline
operating profit margin equation
operating profit
———————— x100
sales revenue
what is profit for the year margin
profit for the year margin is a measure of a firm’s profitability by looking at the relationship between profit for the year and sales revenue
what does it mean if profit of the year margin is low
- gross profit or operating profit are in decline
- interest rates have changed
- taxation rates have changed
profit of the year margin equation
profit for the year
————————— x100
sales revenue
sources of finance examples
- debt factoring
- overdrafts
- retained profit
- share capital
- loans
- venture capital
- crowd funding
what is debt factoring
the process of selling the debts owed to a business to
a financial institution
- the business will receive funds immediately but at a
reduced rate
- external source of finance
advantages of debt factoring
- receives a large amount of
the 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
what is retained profit
profit kept within a business from profit for the year to help finance
future activities
- internal source
retained profit advantages
- avoids interest repayments
- does not dilute the business
ownership
retained profit disadvantage
- only an option if sufficient retained
profit exists within the business - may cause shareholder dissatisfaction
if this is at the expense of dividend
payments - reduces the security blanket of
keeping retained profits for
unforeseen situations or to take
advantage of new opportunities
what is share capital
- finance raised from the sale of shares
- this is a form of equity capital i.e. the shareholder
- becomes a part owner of the business
shareholders will be rewarded for their investment by the payment of dividends
share capital advantages
- only need to pay dividends
if a profit is being made and
the amount of dividend is
not fixed - possible to raise large
amounts of finance - no interest repayments
share capital disadvantages
- loss of ownership as
shareholders are part
owners - potential risk of loss of
control for a Plc with a
threat of hostile takeovers - complex and costly process
of issuing shares, especially
for a Plc
what is venture capital
- investment from an established business into another business
in return for a percentage equity in the business
venture capital advantages
- potential for large sums of money
for investment - expertise to help the business
- makes it easier to attract other
sources of finance - provides the required capital for
expansion
venture capital disadvantages
- long and complex process
- expert financial projections are
likely to be required - initially expensive for the firm
e.g. legal and accounting fees - partial loss of ownership
- risk of conflict or perceived
interference
