Unit 5 Finance PT2 Flashcards
define The break-even point
The break-even point is the amount of sales when a business’ revenue is equal to the total costs of a business. At this point, the business is not making a profit or a loss.
what is break-even analysis
how is it used
what does it tell the business
Businesses use this to calculate the output needed to make a profit.
If the business sells more than the break-even level of output then it will make a profit and if it sells less, it will make a loss
The break-even level of output is the level of output at which the firm’s revenue is equal to the total costs.
Break-even analysis can be shown by a break-even chart which shows total costs, revenue, and profit on the y-axis and output on the x-axis.
define the margin of safety
The margin of safety is how much output (or predicted output) would have to fall by until the business reached the break-even level of output
The margin of safety is the gap between the actual output and the break-even point
Limitations to break-even analysis
Break-even analysis makes some assumptions that may not be accurate in reality.
Assumes the firm will be able to sell all of the units that it produces.
Assumes the firm would not have to change the price when output changes.
Cash inflows is the cash coming into the business.
Cash outflows
Cash outflows are the cash going out of the business.
Net cash flows are equal to cash inflows minus cash outflows.
Opening balance
Opening Balance is the amount of cash that the business starts to trade with.
A negative net cash flow may not create a liquidity problem if the business has a high opening cash balance.
Closing balance
Closing balance – the amount of cash that a business finishes trading with.
Cash flow forecasts are a business’ prediction of how much money will come in and out of the business in a given amount of time
Cash flow forecasts
Businesses will estimate all the possible sources of cash inflows (e.g. sales) and cash outflows (rent, salaries, costs of production).
They may be able to forecast these inflows and outflows using past data on sales and costs, as well as using market research.
Forecasting liquidity problem
it is important for businesses to forecast this accurately to avoid liquidity problems.
A liquidity problem is when a business runs out of cash in the short term. They won’t have enough cash to pay rent and employees’ wages
To solve a liquidity problem, a business has to reduce (or delay) cash outflows and increase (or get sooner) cash inflows.
Forecasting liquidity problem
it is important for businesses to forecast this accurately to avoid liquidity problems.
A liquidity problem is when a business runs out of cash in the short term. They won’t have enough cash to pay rent and employees’ wages
To solve a liquidity problem, a business has to reduce (or delay) cash outflows and increase (or get sooner) cash inflows.
Forecasting liquidity problem
it is important for businesses to forecast this accurately to avoid liquidity problems.
A liquidity problem is when a business runs out of cash in the short term. They won’t have enough cash to pay rent and employees’ wages
To solve a liquidity problem, a business has to reduce (or delay) cash outflows and increase (or get sooner) cash inflows.
Employees
If a firm runs out of cash, it may be unable to pay its employees.
If employees are worried about cash, this can have a negative impact on employee motivation and they may leave the firm.
Creditors
Creditors are organizations (or people) that have loaned business money. If a business runs out of cash, it may not be able to repay these loans.
If this happens, the business may not be able to get loans (finance) in the future or it may pay a higher interest rate
Suppliers
if a business runs out of cash, it may not be able to pay its suppliers.
This could create a temporary halt (stop) in production. It may also damage the relationship between the business and suppliers.
Finding new sources of finance
Finding other sources of finance can provide a firm with the money they need to overcome a liquidity problem.
Finding new sources of finance
Finding other sources of finance can provide a firm with the money they need to overcome a liquidity problem.
Increasing cash inflows
Increasing sales, chasing customers that owe money and selling assets can all increase cash inflows.
Overdrafts
Overdrafts allow a business to have a negative current account balance in the short term.
Banks effectively provide “bridging finance” to plug a short-term shortfall (or lack) of cash.
Reducing cash outflows
A business can try to reduce cash outflows if they predict a liquidity problem.
Delaying the payment of bills is one way to do this. For example, a business change the payment dates for loans and try to secure trade credits.
Forecasts are useful because the earlier a company predicts a cash shortfall, the better they can adjust their cash payments.
Rescheduling cash payments
A business could delay payment to suppliers via things like trade credits
If a business predicted negative cash flow in February but a positive one in March, it may be able to delay the payment until March.
