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Business > Unit 5 - Financial Management > Flashcards

Unit 5 - Financial Management Flashcards

1
Q

Why is it important to set financial objectives?

A
  • without financial security a business will cease to trade
  • poor financial management is a key reason for failure
  • financial measures determine success of all other functions
  • easier to manage as quantitative
  • high levels of long term debt increases risk in business
    • financial objectives may reduce risk
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2
Q

What are the three financial objectives?

A
  • revenue
    • for growth
  • costs
    • reducing costs to improve efficiency
      • especially products with low profit margins
  • profit
    • key incentive
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3
Q

What is revenue?

A

the money made from sales

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4
Q

What is the formula for revenue?

A

revenue = no. of sales x selling price

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5
Q

What are fixed costs?

A

costs that don’t change with output

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6
Q

What are variable costs?

A

costs that change with output

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7
Q

What is the formula for variable costs?

A

variable costs = variable cost per unit x no. of sales

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8
Q

What are total costs?

A

all costs added

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9
Q

What is the formula for total costs?

A

total costs = fixed costs + total variable costs

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10
Q

What is the difference between cash and profit?

A
  • cash considers the timing of payments in and out of the business
  • profit is measured over a period of time

a business can be very profitable but still run out of cash

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11
Q

What is the formula for profit?

A

profit = revenue - expenditure

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12
Q

Why may profitable firms be short of cash?

A
  • high inventory costs
  • sales are on credit (trade credit)
    • buy now, pay later
  • used profits to pay dividends or repay long term loans
  • purchased fixed assets (non-current)
    • e.g. factory or new IT system
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13
Q

What are the three types of profit? / What is the process from revenue to net?

A
  • revenue
    • take away direct costs
  • gross
    • take away indirect costs (salaries, rent, etc)
  • operating
    • take away tax and dividends
  • net
    • profit for the year
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14
Q

What is the formula for gross profit?

A

gross profit = revenue - cost of sales

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15
Q

What does gross profit show?

A
  • how efficiently a business is converting raw materials into finished goods
  • indicates how well a business is adding value
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16
Q

What is cost of sales?

A
  • items of expenditure that are directly related to production
    • wages, raw materials, inventory
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17
Q

What is the formula for operating profit?

A

operating profit = gross profit - expenses

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18
Q

What is operating profit?

A
  • profit made from trading
  • best measure of a company’s performance
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19
Q

What is the net profit?

A
  • profit available to owners
  • includes all revenue
    • including non-trading revenue such as sale of assets
  • includes all expenditure
    • finance costs such as interest payments on loans
    • taxation
  • useful measure for shareholders as it shows how much they benefit from their ownership
  • help existing and potential shareholders to judge whether the company is a good investment
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20
Q

Income Statement:
1. revenue = £17,680
2. cost of sales = £16,606
3. gross profit
4. expenses = £1,169
5. operating profit
6. taxation = £62
7. net profit

Calculate the gross profit, operating profit and net profit. State whether the business has made a profit or loss.

A

gross profit = 17,680 - 16,606 = £1,074

operating profit = 1,074 - 1,169 = £ - 95

net profit = -95 - 62 = £-157

Made a loss

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21
Q

What are cash flow objectives?

A
  • maintaining specific amounts of cash in reserve
  • shortening payment period for customers
  • extending cash outflows to suppliers
    • e.g. pay supplier in 2 months (with supplier agreement)
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22
Q

What are inflows?

A

sums of money entering the business

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23
Q

What are examples of inflows?

A
  • sales
  • capital investment
  • bank loans
  • government grants
  • receipts from trade customers
  • sale of spare assets
  • payments from debtors (receivables)
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24
Q

What are outflows?

A

sums of money leaving the busniess

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25
Q

What are examples of outflows?

A
  • payments to suppliers
  • rent and rates
  • wages and salaries
  • utility bills
  • advertising
  • repayment on loans
  • payment of dividends
  • interest on loans
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26
Q

What is the formula for net cash flow?

A

net cash flow = total inflows - total outflows

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27
Q

What are investment and return objectives?

A
  • target for capital investment over the year
    • aligned with growth targets
  • reducing capital over the year to reduce debt
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28
Q

What is the formula for return on investment (ROI)?

A

ROI = ( profit of investment / cost of investment ) x100

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29
Q

What is the definition of investment?

A

capital goods which include machinery, delivery vehicles, factories and offices

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30
Q

What is return on investment?

A

financial gains from investment - cost of investment

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31
Q

What are the advantages of setting financial objectives?

A
  • acts as a focus
  • measures success or failure
  • gives a common purpose
  • improves efficiency as learn from past mistakes
  • shareholders can assess whether business is worthwhile investment
  • outside organisations can confirm financial viability of business
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32
Q

What are the disadvantages of setting financial objectives?

A
  • difficult to set realistic objectives
  • external changes may be unforeseen
  • certain objectives difficult to measure
  • potential conflict of objectives
  • responsibility for achievement of objectives may rest with finance department, but the actual performance depends on performance of all departments
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33
Q

What is a budget?

A
  • a financial plan for the future
  • not a forecast
  • sets out financial targets
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34
Q

What is the purpose of a budget?

A
  • control and monitoring
  • motivation
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35
Q

What are the three types of budget?

A
  • income budget
  • expenditure budget
  • profit budget
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36
Q

What is the income budget?

A
  • shows agreed planned income of a business over a period of time
  • also known as revenue budget or sales budget
  • includes revenue and any rent received
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37
Q

What is the expenditure budget?

A
  • shows the agreed planned expenditure of a business over a period of time
  • includes raw materials, labour costs, marketing expenditure, admin costs, rent, capital costs, etc
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38
Q

What is the profit budget?

A
  • shows the agreed planned profit of a business over a period of time
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39
Q

Using the data below, complete the budgets.

Budgeted sales for June 2017
- Product A: 7,500 units at price of £3.50 each
- Product B: 8,000 units at price of £2.50 each

Budgeted costs for June 2017
- Raw material costs: 36% of sales income
- Wages: 30p per unit for both Products A and B
- Rent: £3,500

A

Income Budget
- Source of income = income (£)
- Product A = 7,500 x 3.50 = 26,250
- Product B = 8,000 x 2.50 = 20,000
- Total = 26,250 + 20,000 = 46,250

( sales revenue = units sold x selling price)

Expenditure Budget
- Expenditure item = expenditure (£)
- Raw materials = 46,250 x 0.36 = 16,650
- Wages = (7,500 + 8,000) x 0.30 = 4,650
- Rent = 3,500
- Total = 16,650 + 4,650 + 3,500 = 24,800

Profit Budget
- Income / Expenditure item = £
- Total income = 46,250
- Total expenditure = 24,800
- Budgeted Profit = 46,250 - 24,800 = 21,450

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40
Q

What is variance?

A

a comparison between the budget and the actual finance figures achieved

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41
Q

What is the formula for variance?

A

variance = budget - actual figure

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42
Q

What are the two types of variance?

A
  • favourable
  • adverse
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43
Q

What is favourable variance?

A
  • occurs when a cost is less than expected or a revenue is more than expected
  • more profit than expected = favourable variance
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44
Q

What is adverse variance?

A
  • occurs when a cost is more than expected or a revenue is less than expected
  • less profit than expected = adverse variance
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45
Q

What is the variance for the figures below?

Budget
- Revenue
- 2019 Budget = 100 million
- 2019 Actual = 110 million
- Expenses
- 2019 Budget = 50 million
- 2019 Actual = 80 million

A

Revenue Variance
- 110 million - 100 million = 10 million
- more revenue than expected
- favourable variance

Expenditure Variance
- 80 million - 50 million = 30 million
- more expenditure than expected
- adverse variance

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46
Q

Calculate and fill in the ?

Income Budget
Source of income
- Product A
- Budget (£) = 26,250
- Actual (£) = 28,000
- Variance (£) = 1,750 (favourable)
- Product B
- Budget (£) = 20,000
- Actual (£) = 16,500
- Variance (£) = ?
- Total Income
- Budget (£) = 46,250
- Actual (£) = ?
- Variance (£) = ?

A
  • Product B
    • Variance (£) = 20,000 - 16,500 = 3,500 (favourable)
  • Total income
    • Actual (£) = 28,000 + 16,500 = 44,500
    • Variance (£) = 46,250 - 44,500 = 1,750 (favourable)

Variance = Budget - Actual

Variance is favourable as there is more revenue than expected

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47
Q

Expenditure Budget
Expenditure item
- Raw materials
- Budget (£) = 16,650
- Actual (£) = 15,200
- Variance (£) = ?
- Wages
- Budget (£) = 4,650
- Actual (£) = 5,620
- Variance (£) = ?
- Rent
- Budget (£) = 3,500
- Actual (£) = 3,500
- Variance (£) = ?
- Total Expenditure
- Budget (£) = ?
- Actual (£) = ?
- Variance (£) = ?

A
  • Raw materials
    • Variance (£) = 16,650 - 15,200 = 1,450 (favourable)
  • Wages
    • Variance (£) = 4,650 - 5,620 = -970 (adverse)
  • Rent
    • Variance (£) = 3,500 - 3,500 = 0 (no variance)
  • Total Expenditure
    • Budget (£) = 16,650 + 4,650 + 3,500 = 24,800
    • Actual (£) = 15,200 + 5,620 + 3,500 = 24,320
    • Variance (£) = 24,800 - 24,320 = 480 (favourable)
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48
Q

Profit Budget
Income / Expenditure item
- Total income
- Budget (£) = 46,250
- Actual (£) = ?
- Variance (£) = ?
- Total expenditure
- Budget (£) = ?
- Actual (£) = ?
- Variance (£) = ?
- Budgeted Profit
- Budget (£) = ?
- Actual (£) = ?
- Variance (£) = ?

Look at previous cards for information

A
  • Total income
    • Actual (£) = 44,500
    • Variance (£) = 1,750 (favourable)
  • Total Expenditure
    • Budget (£) = 24,800
    • Actual (£) = 24,320
    • Variance (£) = 480 (favourable)
  • Budgeted Profit
    • Budget (£) = 46,250 - 24,800 = 21,450
    • Actual (£) = 44,500 - 24,320 = 20,180
    • Variance (£) = 21,450 - 20,180 = 1,270 (favourable)

Variance = Budget - Actual
Profit = Revenue - Expenditure

POSSIBLY CHECK WITH DARRIE

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49
Q

Why is cash important?

A
  • pays for overheads
  • if cash runs out, business is in financial difficulty
  • businesses don’t have access to unlimited finance, so cash needs to be managed carefully
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50
Q

What is a cash flow forecast?

A

a prediction of the cash coming in and going out of a business

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51
Q

Why is a cash flow forecast important?

A
  • negative cash flow (cash flow deficit) is the main reason for failure
  • helps prevent insolvency
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52
Q

What is the definition of insolvent?

A
  • when a business can no longer pay its debts or staff wages
    • as they have no cash
    • would need to sell assets to repay debts
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53
Q

What is another term for inflows?

A

receipts

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54
Q

What is another term for outflows?

A

payments

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55
Q

What is the formula for the opening balance?

A

opening balance = closing balance of previous period

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56
Q

What is the formula for the closing balance?

A

closing balance = opening balance + net cash flow

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57
Q

When calculating closing balance, what must you do if net cash flow is negative?

A

put it in brackets

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58
Q

What are the advantages of having a cash flow forecast?

A
  • identify potential cash flow problems in advance
  • a guide towards actions to avoid problems
  • ensure there is sufficient cash to pay suppliers and customers and make payments
  • evidence to support bank loans
  • avoid possibility of liquidation
  • identify possibility of holding too much cash and not utilising it effectively
    • e.g. for further investment
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59
Q

What are the disadvantages of having a cash flow forecast?

A
  • there may be changes in demand
  • economic changes can impact customer spending
  • may be based on inaccurate market research
  • doesn’t take into account the actions of rivals
    • e.g. new entrants or increased marketing actions
  • unexpected cost changes
    • e.g. supplier costs increase
  • customers or suppliers failing
60
Q

What is liquidity?

A
  • refers to a business’ ability to maintain cash within the business to pay its operating costs
  • how quickly it can turn assets into cash
61
Q

How can liquidity be improved?

A
  • better use of assets
    • empty warehouse/office could be hired to other businesses
  • make sure as little interest as possible is being paid on borrowing
    • pay debts early and consolidate debts
  • negotiate payment dates with suppliers
  • avoid offering discounts for early payments
62
Q

How can a business improve cash flow?

A
  • speed up inflows
    • discount early payments
    • reduce trade credit lengths
    • de-stock
    • get a loan or overdraft
  • slow down outflows
    • delay paying creditors
    • reduce costs
63
Q

What is break even?

A
  • when the total revenue is equal to the total costs
  • at this point the business is making neither a profit or loss
64
Q

What is contribution?

A

how much money a product contributes towards fixed costs

65
Q

What is the formula for contribution?

A

contribution = selling price - variable costs

66
Q

What is the formula for break even?

A

break even = fixed costs / contribution

67
Q

What does break even tell a business?

A

how many products need to be sold to break even (make neither profit nor loss)

68
Q

A cake shop has fixed costs of £21,000.
The selling price of a cake is £5 and the variable cost of a cake is £2.
Calculate the break even point.

A

break even = 21,000 / (5 - 2) = 7,000 cakes

69
Q

What is the margin of safety?

A

the difference between the actual level of sales and the break even point

70
Q

What is the formula for margin of safety?

A

margin of safety = actual sales - break even point

71
Q

The following monthly data is available for a business:
Selling price per unit = £42
Variable costs = £14
Total fixed costs = £42,000
Actual sales for month of June = 4,000 units

How much is the margin of safety for the business for the month of June?

A

break even = fixed costs / contribution
contribution = selling price - variable costs

break even = 42,000 / (42 - 14) = 1,500

margin of safety = actual sales - break even point

margin of safety = 4,000 - 1,500 = 2,500

72
Q

Draw a break even chart.

A

See notes or powerpoint.

73
Q

Draw a break even chart with:
1) an increase in price
2) a decrease in price

A

See powerpoint.

74
Q

How can you change the break even point?

A
  • increase/decrease fixed costs
  • increase/decrease variable costs
75
Q

What happens to break even with an increase/decrease in fixed costs?

A

more/less units need to be sold in order to generate enough total contribution to cover the higher/lower fixed costs and therefore break even

76
Q

What happens to break even with an increase/decrease in variable costs?

A

more/less contribution per unit will be generated compared with the selling price, so more/less units will need to be sold in order to cover the fixed costs and therefore break even

77
Q

What are the advantages of break even?

A
  • allows business to plan how many products need to be sold in order to start making profit
  • break even info can be used to make judgements about costs and prices
  • supports applications for bank loans
78
Q

What are the disadvantages of break even?

A
  • break even assumes the business sells all products at a single price
    • doesn’t take into account offers etc
  • not as accurate because it is either the break even for all products or for the average of all products
  • assumes costs increase constantly
    • doesn’t take into account economies of scale
79
Q

What is profitability?

A

a measure of an organisation’s profit relative to its expenses

80
Q

What does the gross profit margin show?

A

shows the gross profit as a percentage of revenue
- e.g. GPM of 20% means that for every £1 of revenue, 20p is the gross profit

81
Q

What is the formula for gross profit margin?

A

gross profit margin = ( gross profit / revenue ) x 100

82
Q

What does the net profit margin show?

A

shows the net profit as a percentage of revenue
- e.g. NPM of 5% means for every £1 of revenue, 5p is the net profit

83
Q

What is the formula for net profit margin?

A

net profit margin = ( net profit / revenue ) x 100

84
Q

Out of gross profit margin and net profit margin, which is a greater indicator of a business’ profitability?
Why?

A

net profit margin
- because it includes the sames costs as GPM, and fixed costs
- therefore is a better indicator

85
Q

How can a business improve profit?

A
  • increase prices
  • use cheaper raw materials
  • increase marketing
  • increase capacity utilisation
  • relocate to cheaper premises
  • negotiate deals with suppliers
86
Q

What are the difficulties in improving profit?

A
  • spend money to make money
  • lower quality products if use cheaper raw materials
  • there are always consequences, so context is important to assess difficulty
87
Q

Why do businesses need finance?

A
  • expand business
  • but new equipment
  • buy premises
  • fund research and development
  • pay bills
  • buy stock
  • develop marketing activities
  • pay workers
  • start new business
88
Q

Why are some sources of finance not available to every business?

A
  • sole traders and partnerships
    • cannot sell shares to raise finance
  • limited companies (LTD or PLC)
    • cannot take extra partners to raise finance
  • businesses with poor financial record
    • unlikely to get bank loan
89
Q

What are the 3 time frames of finance?

A
  • short term
  • medium term
  • long term
90
Q

What is short term finance?

A
  • usually money required up to a year
  • day to day expenses
  • revenue expenditure
91
Q

What is medium term finance?

A
  • usually money needed for 1 to 3 years
  • for new machinery etc
  • capital expenditure
92
Q

What is long term finance?

A
  • money needed for over 3 years
  • usually for major business investments
93
Q

What are the 2 types of sources of finance?

A
  • internal
  • external
94
Q

What are internal sources of finance?

A

finance found inside the business

95
Q

What are external sources of finance?

A

finance found outside the business

96
Q

What are internal sources of finance usually used for?

A

short or medium term finance
- except retained profits, which is medium to long term

97
Q

What are examples of internal sources of finance?

A
  • sale of assets
  • owners’ capital
  • sale and leaseback
  • retained profits
98
Q

What is sale of assets?

A

where a business sells off part of the business or equipment which they no longer want to run or which is unprofitable or outdated

99
Q

Is sale of assets short, medium or long term?

A

short/medium term

100
Q

What are the advantages of sale of assets?

A
  • may be able to sell land or equipment to release the money, and then lease it back off new owner
  • saves money
101
Q

What are the disadvantages of sale of assets?

A
  • can no longer use what was sold
  • may have to buy more expensive equipment to replace what was sold
  • may take a long time to find buyer and sell asset
102
Q

What is sale and leaseback?

A

immediate cash can be acquired by selling off a property the business owns and then renting/leasing it back from the new owner

103
Q

Is sale and leaseback short, medium or long term?

A

short/medium term

104
Q

What are the advantages of sale and leaseback?

A
  • immediate cash
105
Q

What are the disadvantages of sale and leaseback?

A
  • business no longer has that asset
  • the rent may be more than the mortgage of the building
106
Q

What is owners’ capital?

A

existing owners of business may invest more money in it from their savings

107
Q

Is owners’ capital short, medium or long term?

A

short/medium term

108
Q

What are the advantages of owners’ capital?

A
  • no need to repay money
  • no interest to be paid
109
Q

What are the disadvantages of owners’ capital?

A
  • owners may not have enough savings
    • will need to look at other sources of finance
110
Q

What are retained profits?

A

the part of the business’ profit that is reinvested in the business rather than distributed to shareholders

(also known as ploughed-back profit)

111
Q

Is retained profits short, medium or long term?

A

medium/long term

112
Q

What are the advantages of retained profits?

A
  • don’t have to pay interest or dividends on the money = cheaper
  • don’t have to look at other sources of finance
113
Q

What are the disadvantages of retained profits?

A
  • shareholders will expect a certain amount of profit as reward for buying shares, so dividends will have to be paid
  • only available to businesses that have made a profit
114
Q

What are examples of external sources of finance?

A
  • overdraft
  • ordinary share capital
  • bank loan
  • venture capital
  • taking on new partner
  • crowd funding
  • trade credit
  • debt factoring
115
Q

What is an overdraft?

A

when a bank allows the business to overspend its current account with the bank up to an agreed limit and for a stated period of time

116
Q

Is an overdraft short, medium or long term?

A

short term

117
Q

What are the advantages of an overdraft?

A
  • can meet short term cash flow problems
  • used to pay day-to-day expenses
  • flexible and so useful for seasonal businesses
118
Q

What are the disadvantages of an overdraft?

A
  • interest is charged on the daily amount of money that the business owes the bank
    • can be expensive
119
Q

What is ordinary share capital?

A
  • new shares are sold, raising money for the business
  • buyers of the shares become shareholders
  • the investor can earn a dividend
120
Q

Is ordinary share capital short, medium or long term?

A

long term

121
Q

What are the advantages of ordinary share capital?

A
  • finance raised may be used to fund major business development such as take over, extension
  • money doesn’t have to be paid back
  • no interest
122
Q

What are the disadvantages of ordinary share capital?

A
  • dividends may have to be paid on the shares
  • shareholders entitled to have a say in the running of the business
  • business may be taken over and existing shareholders no longer own the business
123
Q

What is a bank loan?

A
  • business borrows fixed amount of money from the bank
  • pays it back over a period in regular installments
  • interest paid on it
  • bank may want to take a security (asset it can sell to recover its money)
124
Q

Is a bank loan short, medium or long term?

A

medium/long term

125
Q

What are the advantages of a bank loan?

A
  • repayment is spread over time
  • know how much will pay back each month
    • helps budgeting
126
Q

What are the disadvantages of a bank loan?

A
  • interest can be expensive
  • bank needs security/collateral, and if fail to pay, can take this in return (car, premises, etc)
127
Q

What is venture capital (Business Angels)?

A
  • finance provided to small or medium firms that seek growth, but may be considered risky by other lenders or share buyers
128
Q

Is venture capital short, medium or long term?

A

medium/long term

129
Q

What are the advantages of venture capital?

A
  • source of advice and contacts
130
Q

What are the disadvantages of venture capital?

A
  • give up some ownership of the business
131
Q

What is trade credit?

A
  • when a business receives goods from a supplier now and can pay up to 30 days later for no extra charge
  • gives business time to sell them on before making a payment
  • only given to reliable businesses
132
Q

Is trade credit short, medium or long term?

A

short term

133
Q

What are the advantages of trade credit?

A
  • effectively free loan with no interest charges
  • increases amount of cash in business which can be used for other things
134
Q

What are the disadvantages of trade credit?

A
  • still have to pay even if the goods haven’t sold
  • interest is charged if credit not paid within the time limit
135
Q

What is crowd funding?

A
  • money raised from ‘sponsors’
  • usually by advertising business idea on crowd fund raising website
136
Q

Is crowd funding short, medium or long term?

A

medium/long term

137
Q

What are the advantages of crowd funding?

A
  • sponsors can donate money, lend money or become part owner of the business
138
Q

What are the disadvantages of crowd funding?

A
  • profits may need to be shared if equities are sold
139
Q

What is taking a new partner to raise finance?

A
  • partnerships can obtain additional finance by selling off part of the business to a new partner
  • sole traders and partnerships only
140
Q

Is taking on a new partner short, medium or long term?

A

long term

141
Q

What are the advantages of taking a new partner?

A
  • new skills and ideas
  • finance the partner beings may be used to buy new equipment or premises or buy another business
142
Q

What are the disadvantages of taking a new partner?

A
  • new partner will have a say in running of business
  • new partner entitles to share of profits
143
Q

What is debt factoring?

A
  • when a factoring company (usually bank) buys the right to collect the money from credit sales of a business
  • selling off debt to a third party
144
Q

Is debt factoring short, medium or long term?

A

short term

145
Q

What are the advantages of debt factoring?

A
  • collecting and chasing up debts can be costly and time consuming
    • factoring company specialises in this
  • potential for factoring company to get more than one debt from same firm
146
Q

What are the disadvantages of debt factoring?

A
  • business using the factoring company may lose between 5% and 10% of what it is owed
    • debt factoring company needs to be paid
147
Q

What is an example of how debt factoring works?

A
  • sell debt for £80 instead of £100 to a third party
  • the third party gets the money (£100) from the person that owed money
  • the third party gains £20, and you lose £20 but don’t have the hassle of chasing the money

Business (16 decks)

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