Unit 5 - Finance Flashcards
Budget
A financial plan for the future concerning the revenues and costs of a business
Managers use budgeting to… (2)
- help control spending
- to help plan when money is coming in (inflow)
Variances
The difference between the budgeted amount and the actual amount
Uses of budgets in management (5)
- to set targets
- provides direction and coordination
-Allocate resources - control income and expenditure
- forecast outcomes
What is historical budgeting
Using last years figures as a basis for the budget and is based on actual results.
( however circumstances may of changed and doesn’t encourage efficiency)
What is zero budgeting
Budget is based on new proposals for costs and sales and budgeted costs and revenues are set to zero.
(More realistic but time consuming )
Types of Budget (3)
- Revenue (income) budget - expected revenues and sales.
- Cost ( expenditure) budget - expected costs based on sales budget
- Profit budget - based on the combined sales and cost budgets
What is a favourable budget
Having more money than we expected/ budgeted for
What is an adverse budget
When we have less money than expected / budgeted. ( figure will be negative)
Variation calculation
Variation = actual - expected (budgeted)
Reasons why a budget may be favourable (4)
- switching to a cheaper supplier / buying in bulk
- rising demand for the product
- competition is going out of business.
- improved productivity.
Reasons why a budget may be adverse
- inflation on raw materials and staff costs can lead to higher costs
- products going out of fashion can lead to reduced sales
- higher tariffs ( tax on foreign imports and exports) and weaker currency exchange rates can’t cause impact costs to rise
Problems and limitations of budgets (4)
- can lead to inflexibility in decision making
- need to be changed as circumstances change
- can result in short term decisions to keep within the budget
- take time to complete and manage
What is break even
The point at which profit is zero, so the revenue from selling products is the same as the total costs incurred in producing/ providing them.
Break even point calculation
BEP = FIXED COSTS / (SELLING PRICE - VARIABLE COST PER UNIT)
Contribution calculation
CONTRIBUTION = SELLING PRICE - VARIABLE COSTS OF PRODUCTION
Total contribution
TOTAL CONTRIBUTION = CONTRIBUTION PER UNIT X QUANTITY
profit calculation (2)
- PROFIT = TOTAL CONTRIBUTION - FIXED COSTS
- PROFIT = CONTRIBUTION PER UNIT X MARGIN OF SAFETY
What is the margin of safety
A measure of how close business is to its break even level
Margin of safety calculation
MARGIN OF SAFETY = OUTPUT - BEP
Revenue changes to the BEP (3)
- an increase in selling price will decrease the BEP
- revenue line steepens as price increases because more contribution is being made on each unit.
- extra contribution means fixed costs can be covered more quickly
Variable costs changes to the BEP (3)
- an increase to variable costs increases the BEP
- VC line and total cost line becomes steeper as less contribution is being made on each unit
- smaller contribution means fixed costs can’t be covered as quickly so more needs to be produced to make break even
Fixed costs changes to the BEP
- increase in fixed costs increases BEP
- Higher costs means more needs to be produced to cover them
Benefits of BEP analysis (3)
- helps management and finance provide bettered understand the viability and risk of a business idea
- focuses on what output is required before a business reaches profitability
-margin of safety calculation shows how much sales forecast can prove over optimistic before before losses are incurred
Limitations of BEP analysis (3)
- unrealistic assumptions
- variable costs don’t always stay the same
-a planning aid rather than a decision making tool
What is cash flow
A measure of how and when money is flowing in and out of a business
Net flow calculation
NETFLOW = INFLOW - OUTFLOW
How does money flow in to a business (4)
- selling products
- profit on investments
-Interests on savings - renting out property
How does money flow out of a business (4)
- rent
- wages and salaries
- repaying loans
-tax
What is liquidity
A measure of how easily a firm can turn its assets into cash
Assets in order of liquidity ( most first)
Cash
Cheque
Money owed by customer
Inventory
Property
3 year debenture
Why produce a cash flow forecast?
- gives advanced warning of cash shortages
- ensures you can afford to pay suppliers and employees on time
- spot problems with customer payments
- provide reassurance to investors and lenders that the business is being managed properly
Closing balance
CLOSING BALANCE = OPENING BALANCE + NET FLOW
What is a cash flow problem
When a business doesn’t have enough cash to be able to pay its liabilities
Why might a business experience a cash flow problem? (5)
- loss making
- inaccurate/ poor / overly optimistic forecasting
- excess stock
- Bad debts
- seasonal demand
Managing accounts owed by customers (4)
- credit control - decide how much credit to give and the repayments terms
- debt factoring - sell accounts receivables to a 3rd party at discount
- cash discounts
- improved record keeping
Advantages and disadvantages of debt factoring
+ provides instant working capital
- short term debt
Advantages and disadvantages of cash discounts
+ access funds faster so improves cash flow
- can reduce profit margins
- cards are more convenient to customer
Advantages and disadvantages of improved record keeping
+ accurate forecasting and timely invoicing
- time consuming
How to manage accounts owed by suppliers (3)
- agree longer credit terms with suppliers to give you more time to repay
- spread payments into manageable chunks over more time
- find cheaper suppliers
How to manage inventory (3)
- keep smaller balance ( just in time stocks )
- computerise ordering to improve efficiency
- improve stock control
What is profit in absolute terms
The £ value of profit earned
What is profit in relative terms
The profit seemed as a proportion of sales achieved or investment made
Gross profit margin calculation
GPM = (GROSS PROFIT / REVENUE ) X 100
Gross profit (also the same as contribution) calculation
GROSS PROFIT = REVENUE - COST OF SALES
What is operating profit
What is left after all the normal running costs of a business have even taken from its revenue
Operating profit margin calculation
OPM = (OPERATING PROFIT / REVENUE) X100
What does operating profit tell us ? (3)
- how efficiently a business turns its sales into operating profit
- how efficiently the core business is run
- whether a business is able to add value during production
Operating profit calculation
OP = GROSS PROFIT - OPERATING EXPENSES
Profit for the year margin calculation
PFTYM= (PROFIT FOR THE YEAR / REVENUE) X 100
What is a bank overdraft
A short term finance which lets you borrow money through current account by taking more money than you have in the bank
+ and - of bank overdraft
+ you can borrow what you need to
+ in control
- likely to be charged for borrowing
- high rates of interest
What is crowd funding
A long term finance which is a way of raising money to finance projects and businesses as it enables fundraisers to collect money for a larger number of people via online platforms
+ and - of crowd funding
+ money may not need to be repaid
+ funds often come from investors
- potential failure to meet goals and not recieve money
What is a grant
A short term finance that is a sum of money awarded to an organisation in anticipation of it being applied for an agreed purpose
+ and - of a grant
+ money doesn’t need to be repaid
+ widely available
+ boost credibility
- contractually bound as you mission needs to meet their needs
- spending is controlled
- have to wait a long time
What is retained profit /savings
A short term finance and is the amount of a business’s net income that is kept within its accounts rather than paid out to shareholders
+ and - of retained profit / savings
+Indicator of the long term financial stability of the business.
+ increased stock value
+ boosts your corporate liquidity therefore, have a financial safety net
- missed investment opportunities
- increased risk
- increased tax implications
What is a hire purchase
A short term finance which is a system where one pays for something in regular instalments
+ and - of a hire purchase
+ option to get newer and higher specification assets
+ flexibility
+ allows businesses to manage cash flows
- risk of asset being repossessed if payments are missed
- you don’t own the asset until the final payment
What is a mortgage
A long term finance which is a loan used to purchase and maintain a house
+ and - of a mortgage
+ lower interest rates than other types of loans
+ can improve your credit score
+ possible long term stability and flexibility
- must payback more than you borrow
- risk of not keeping up with payments
What is share capital
A long term finance which is the money company raise by issuing common / preferred stock
+ and - of share capital
+ more money so more investors
+ support from shareholders
+ seen as more stable
- takes away control from the original owner
- high risk of takeover
What is a venture capital
A short term gain and long term commitment and is a form of equity finance by a venture capitalist/ investment firm
+ and - of venture capital
+ business get access to support, advice and contacts
- loss of control
- loss of profit due to less shares
How to improve profitability (6)
- increase the quantity of goods sold
- change selling price
- reduce variable costs
- reduce fixed costs
- reduce product range
- outsource non essential functions
What is a financial objective
The goals / targets related to the financial performance of a business
Main types of financial objectives (8)
- revenue objectives
- cost objectives
- profit objectives
- cash flow objectives
- investment level objectives
- capital structure objectives
- return on investment objectives
- objectives relating to debts
Benefits of financial objectives
+ improve coordination
+ improve efficiency
+ allows shareholders to assess whether the business is a worthwhile investment
+ enables external stakeholders to confirm the financial validity of a business
Disadvantages of financial objectives
- difficult to set realistic objectives
- external changes may be out of control of business
- difficult to measure accurately
- impossible to determine success or failure
What is return on investment
Financial gains from investments - cost of the investment
Return of investment % calculation
ROI = (RETURN ON INVESTMENT / COST OF THE INVESTMENT) X100
