UNIT 5 - FINANCE Flashcards
What is the finance function?
Can sometimes be referred to as the finance department and is only really found in larger businesses.
What are the roles of the Finance Function?
- Prepare and create financial accounts (profit and loss).
- Keep and maintain financial records (sales).
- Make payments (salaries)
- Provide financial information to aid decision making.
- Analyse the financial performance of the business to produce data.
What is Financial information?
Includes details of profit, loss, cash flow, break- even, profit margin and average rate of return which can all be very helpful for the business when making decisions.
What are examples of short term reasons for finance?
- When cash flow is poor
- Bridge gaps when large customers delay payments
- Produce a sudden rush order from an important customer
- Marketing
What are examples of long term reasons for finance?
- Start up costs and running costs
- Finance asset purchases
- Expansion
- Fund new product development
What are the two main methods of raising finance?
- Internal
- External
What are examples of internal sources of finance?
Involves raising funds from within the business.
- Retained profit
- Personal savings
- Sale of unwanted assets
- Sale and leaseback
What is retained profit?
Profit that is not distributed to the shareholders and it is put back into the business.
Medium/ long term source of finance for more established businesses.
Pros:
- No interest so flexible
- No need to repay the money
- Doesn’t dilute the business.
Cons:
-Smaller businesses don’t have it yet.
-Shareholders may not be happy that the profit is not going to them.
- If a business is facing difficulties it is unlikely for them to have profits.
What is Owner’s capital?
Money put into the business by the owner.
Sole traders and partnerships only. Suitable for all sorts of finance.
Pros:
- No repaying
- No interest
- No cost at all
Cons:
- Dependent on owners savings.
- Owner is placing their money at risk.
What is sales of assets?
Items of value that the business owns that are sold to raise finance.
Used for all sorts of finance but businesses must be established.
Pros:
- Good way to get rid of useless assets and make money.
- Finance made belongs to the business.
Cons:
- Once the asset is sold it is no longer available to be used.
- The business cant sell the asset for its original value due to depreciation.
- One off situation.
What are examples of external sources of finance?
Involves raising funds from outside the business.
- Overdraft
- Trade credit
- Loans
- Share issue
- Crowdfunding
What is an Overdraft?
An arrangement with a bank that a business can spend more money than is in its account.
Used by all businesses, only short term finance.
Pros:
- Good for short term payments to avoid bankruptcy.
- Available as and when so flexible
Cons:
- Daily charged interest
- If the bank suspects the business struggling it can demand the overdraft back at any time.
What is Trade Credit?
An arrangement whereby a supplier allows the business to receive goods but pay at a later date. (Usually in within 28 days).
Available for all but start-ups may struggle requesting. Short term.
Pros:
- Allows them to use supplies and sell the goods before paying suppliers which will improve cash flow position.
- Usually no interest
Cons:
- Must be paid at an agreed time if not relationship could be broken.
- Sometimes interest is charged if the business doesn’t pay on time.
What is Crowdfunding?
Money raised through a business pitching a product for the public to contribute small bits of money.
Medium/ long term source of finance and start-up businesses.
Pros:
- Provides finance where other methods may be hard.
- Builds awareness and acts as market research.
- Opportunity to start with limited resources.
Cons:
- Lose all money if target is not met.
- Has to be an innovative idea.
What account is used to show Profit and Loss?
The profit and loss account.
How do you calculate Revenue (sales)?
Revenue = Price x Number sold.
How many units of the product have been sold.
You can get it by:
- selling products/ services
- Interest in savings from bank
- Investments such as shares
- Leasing - renting out property
What does the term “costs of sales” mean and how do you calculate it?
Costs of sales = add up all the costs related to the products.
The costs that are directly related to production.
What does the term “gross profit” mean and how do you calculate it?
Gross profit = Revenue - cost of sales.
Shows the level of profit earned from buying and selling goods.
What does the term “net profit” mean and how do you calculate it?
Net profit = Gross profit - Fixed costs
The money that is left after all the costs are taken away from the sales,
What are the two main types of costs?
- Start up costs: these are the costs when the business begins.
e.g Computer or till - Running costs: (operating costs) these are day-to-day costs. e.g fuel for vehicle and electricity.
What are the different types of running costs?
Fixed costs: (overheads) These have to be paid no matter sales or customers.
Variable costs: these are directly related to the number of products sold and produced.
Total costs: Variable and Fixed combined.
How do you calculate Total costs?
Total costs= Fixed costs + variable costs.
What does the term “Expenditure” mean?
All the money going out of the business.
What is profit or Loss and how do you calculate it?
Profit- means the revenue is greater than the expenditures.
Loss- means that the revenue is less than expenditures.
Profit/ Loss = Revenue - Expenditure
What are the two key profitability ratios and how do you calculate them?
- Gross profit margin: % of sales revenue that is gross profit.
=Gross profit/ Sales revenue x 100 - Net profit margin
= Net profit/Sales revenue x 100
What are ways to improve the gross/ net profit margin?
Increase the sales revenue:
- Lowering the selling price might boost demand so much that the business gets an increase in revenue.
- Increasing the price
- Increase product awareness
Lower the cost of sales:
- Negotiate with suppliers
- Cheaper supplies
Reduce expenses:
- Delayer the organizational structure
- Review salaries/ bonuses
- Freeze recruitment
Which out of the two profitability ratios is best?
The net profit margin is a better indication of a businesses financial performance as the ratio takes into account all the expenses. Whereas the gross profit margin only takes into account the cost of sales.
What is the average rate of return and how do you calculate it?
The ARR is a way of comparing the profitability of different choices over the expected life of an investment.
= Average annual profit x
( Total profit/ number of years) / cost of investment x 100
Who might be interested in the profit and loss accounts?
Shareholders - dividends?
Managers - Job role security?
Employees - Wage?
Suppliers - Trade credit?
Customers - Prices may fluctuate and dips in quality?
Government - Tax received?
Competitors - market lead or competing well?
What is break even and how do you calculate it?
The moment when total revenue is equal to total costs; it is the point where the business is not in a profit or a loss.
Money in = Money out
BE = Fixed costs/ (Selling price - variable cost per unit (contribution))
What are the formulas needed for a break even chart?
Total costs = Fixed + Variable
Variable = VC per unit x output
Revenue = Selling price x output
Profit/loss = Revenue - expenditures (total costs)
What is the margin of safety and how do you calculate it?
The amount of sales that can fall before break-even and the business no longer makes a profit. Also telling a business how many sales above break even point it is.
MOS = Actual sales - Break even sales
Why must a business know its break- even point?
- Because the contribution from every unit sold above it adds to profit.
- Provides a focus for the business.
- Works out if the forecast sales will be enough to make a profit.
- Helps a business know whether future investment is worthwhile.
What are the limitations of break- even charts?
- Assumes all stock is sold.
- Does not include market fluctuations.
- Does not allow changes in selling price.
What is contribution and how do you calculate it?
Selling price - Variable costs per unit.
What are the pros of using break- even to aid choices?
- New products:Predicts how many units need to be sold, realistic?
- Pricing: experiment with pricing strategies.
- Costs: Helps decide to change VC e.g suppliers.
- Can help a business plan production levels.
What are the cons of using break even to aid choices?
- Changes in external factors.
- Changes in costs
- Doesn’t work well for services only goods as services can differ between services.
What is the difference between cash and profit?
Cash is all the money that comes into the company. Profit is the cash minus all the costs.
What is the importance of cash to a business?
- Providing liquidity: This means a business meets its short term debts with short term cash.
- To pay suppliers, overheads and employees.
- To prevent business failure.
What is cash flow?
Cash flow is the process of cash flowing in and out of the business.
What is net cash flow and how do you calculate it?
Net cash flow is the difference between cash inflows and outflows over a trading period.
= Cash inflows - Cash outflows
What is a cash flow forecast and what are the calculations needed?
A table showing the predicted opening balances, cash inflows/ outflows, Net cash flows and closing balances over a trading period. (The amount of cash at the end of a trading period).
->Closing balance = Opening balance + net cash flow
->Opening balance = Previous closing balance
What are the problems with cash flow forecasts?
- Sales prove lower than expected; bad market research
- Customers don’t pay on time
- Cost of production proves more expensive
- Certain costs are missed
What are the solutions to cash flow problems?
->Overdraft - Immediate and flexible but interest is high and bank can demand at any time.
-> Re- scheduling payments: Reducing TC period = faster inflows but can lead to disagreements.
-> Reducing cash flow outflows
-> Finding new sources of finance but could dilute ownership and high interest.
Why is a cash flow forecast important?
- Helps sport problems with customer payments.
- Important part of financial planning.
- Identifies potential shortfalls of cash in advance so a business can imply remedies.
- Helps set targets.
