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Y11 BUSINESS > Y11 HL BUSINESS FINANACE > Flashcards

Y11 HL BUSINESS FINANACE Flashcards

1
Q

Why do businesses need finance?

To start-up a business

A

Money to set-up a business. Used to buy equipment, market research, legal fees, refurbish premises.

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2
Q

Short-term needs

A

Money to fund the day to day running of the business when revenue isn’t sufficient to cover all the expenses. This may be because trade is seasonal, the business is waiting payment from a customer or there has been an emergency. Used to buy raw materials, stock, pay bills. The money borrowed is repaid within a year.

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3
Q

Long-term needs

A

The money borrowed takes longer than a year to repay. The owners can provide long-term finance and this is called capital. Long-term loans can also be obtained from banks. Long-term finance may be used to buy equipment and premises.

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4
Q

Expansion

A

Money is required to grow which can include increasing output, developing new products, entering overseas markets

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5
Q

Internal sources of finance

A

Comes from inside the business

  • retained profit
  • personal savings
  • sale of assets
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6
Q

External sources of finance

A

Comes from outside the business

  • bank loan
  • overdraft
  • trade payables
  • share capital
  • stock market flotation for PLCS
  • venture capital
  • crowdfunding
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7
Q

Internal sources of finance

Personal Savings

A

This is the money put into a business by its owner or owners, depending. The money could come from the owner’s savings or redundancy payments. It is particularly applicable for sole traders and partnerships because they cannot sell shares to raise finance. An advantage of personal savings is that there are no interest charges. However, on the other hand, the entrepreneurs may not have enough money to start the business and may also need to use other sources of finance

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8
Q

Internal sources of finance

Retained Profits

A

A successful business will make a profit. Businesses can choose to save some of this profit and this is known as retained profit. This money can then be used for various purposes such as paying off debts or expanding the business (developing new products, opening new shops).

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9
Q

Internal sources of finance

Retained profits advantages

A

Advantages

  • The business does not incur any costs, such as paying interest on a bank loan.
  • It is quick to obtain.
  • Retained profit can earn interest in the bank
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10
Q

Internal sources of finance

Retained profits disadvantages

A

Disadvantages

  • Once the money is used, the business may not have any spare cash to cover unforeseen circumstances.
  • It is only available to successful businesses.
  • Shareholders may be unhappy if the money is not given to them as a dividend.
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11
Q

Internal sources of finance

Sale of Assets

A

Existing businesses may have equipment, land or property that they no longer require which they can sell to raise finance. Sometimes the asset being sold may be part of the business.

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12
Q

Internal sources of finance

Sale of Assets advantages

A

Advantages

  • Does not incur interest charges
  • Assets such as equipment can be sold then leased back. The business has then raised cash but still has use of the asset.
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13
Q

Internal sources of finance

Sale of Assets disadvantages

A

Disadvantages

  • The business may not have assets of any value to sell
  • If the business sells an asset such as a machine, this may lower a businesses’ capacity and how much it can produce. They may require it again at a later date, for example because customer demand increases. They may then have to re-purchase the asset.
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14
Q

External Sources of Finance

Short-term: Overdraft.

A

An overdraft is where a bank allows a business (or an individual) to spend more money than there is in the account, up to an agreed limit. With an overdraft a business only borrows what it needs, when it is needed meaning they are very flexible. This reduces the amount of interest to be paid. However, a bank does not have to give a business an overdraft and the rate of interest charged on an overdraft can be quite high. Furthermore, a bank can demand that an overdraft is repaid within 24 hours. A business can fail if it is not able to do this

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15
Q

External sources of Finance

Short-term: Trade Payables (also called Trade Credit)

A

This is where a business buys materials and pays for them at a later date. This is an inexpensive way for businesses to raise finance and it keeps cash in the business for longer so it can be used for other purposes e.g. advertising. However, suppliers may offer discounts for prompt payment so a business using trade payables may up paying more for the resources it is buying. If a business takes a long time to pay, supplier relationships may be damaged in the long-term. This could be harmful if the business operates Just-in-Time and good relations are needed to ensure suppliers delivery on-time.

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16
Q

External sources of Finance

Short-term: Credit Cards

A

This is where a business buys goods and pays for them at a later date. If the business pays for the goods after the credit period then interest is charged. Interest charges can be high making credit cards an expensive source of finance. Credit cards can be a quick, convenient and flexible way to pay for things and interest can be avoided if the credit card bill is paid within the credit period.

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17
Q

External sources of Finance

Long-term: Bank Loan (Loan Capital)

A

Bank loans are where a bank agrees to lend a business amount of money for a given period of time and the business makes regular repayments. Regular repayments can help with budgeting. Interest is charged by the bank on the loan and this must be paid on-time or the bank will take action against the business and this could result in the business being taken to court and closed down. Most bank loans are secured loans. This means they are secured against an asset such as property. If the business fails to repay the loan then the bank will take this asset instead of the loan repayment. Unsecured loans are where the bank has no claim on an asset if the loan cannot be repaid. Unsecured loans are more risky for the bank so therefore have higher interest charges compared to secured loans. New businesses may find it hard to get a loan because banks perceive them as risky, as their sales may not be sufficient to pay back the loan.

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18
Q

External sources of Finance

Long-term: Hire Purchase (a type of loan)

A

With hire purchase the business pays for the assets in instalments and once all payments have been made the business owns the asset. It can be an expensive way to obtain an asset and goods can be repossessed if a business falls behind with repayments.

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19
Q

External sources of Finance

Long-term: Share Capital

A

This is the money invested by shareholders. Private and Public limited companies can sell shares to raise finance.

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20
Q

External sources of Finance

Long-term: Share Capital advantages

A

Advantages

  • Selling shares can be cheap and easy
  • No interest is payable to shareholders, therefore reducing costs
  • May be able to raise larger sums of money because more people are contributing
  • Public limited companies can sell shares on the stock exchange to raise large sums of money.
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21
Q

External sources of Finance

Long-term: Share capital disadvantages

A

Disadvantages

  • As shareholders, they own part of the company and are entitled to a share of any profits the business makes.
  • Shareholders are entitled to a say in how the business is run so if the entrepreneur sells too many shares they may lose control of the business.
  • The process of selling shares can be costly
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22
Q

External sources of Finance

Long-term: Venture Capital

A

Venture Capitalists can be individuals or businesses and they specialise in giving loans to small and medium sized businesses. Individual venture capitalists are also known as business angels. Venture Capitalists often have a stake in the business to enable them to have some control over decision making and a share of any profits. Venture Capitalists may invest in new or recently started businesses which are more risky and as a result businesses may seek finance from a venture capitalist if they have not been able to obtain finance elsewhere, for example from banks.

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23
Q

External sources of Finance

Long-term: Crowdfunding

A

This is where large numbers of people invest in a business using the internet. Businesses seeking crowdfunding can put details online on crowdfunding websites such as why they need the money, how much is needed and what benefits investors may enjoy if the venture successful. Crowdfunding can be used for community projects as well as business ventures.

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24
Q

How does a business decide which source of finance to use?

Business’ Financial Situation

A

If a business has been profitable in the past it is likely to have retained profits within the business, so this source of finance should be available to successful businesses. Past success should help a business convince a bank to lend it money as it is more likely to be able to repay a loan.

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25
Q

How does a business decide which source of finance to use?

Cost of finance

A

Some sources of finance can be more expensive than others and costs can impact profits. For example interest is payable on bank loans but not on share capital. Cost may come in other forms, for example venture capitalists may want a stake in the business and therefore some control over decision-making.

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26
Q

How does a business decide which source of finance to use?

Level of risk

A

Loans can be more risky because interest is payable. If the loan is secured on an asset then a bank may repossess this asset if loan repayments are not made.

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27
Q

How does a business decide which source of finance to use?

Type and size of business

A

Only companies can sell shares to raise finance. As public limited companies can sell shares to the public on the stock exchange they can sell more shares and therefore raise more money than private limited companies who can only sell shares to family and friends. Also, private limited companies have to gain the consent of all existing shareholders before selling more shares. Sole traders cannot sell shares and so are more restricted in the options of available, for example bank loans and own capital.

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28
Q

How does a business decide which source of finance to use?

What the money is to be spent on

A

Long-term sources of finance are more suitable when large sums of money are needed, for example to finance the purchase of new machinery. Short-term finance is used for smaller amounts of money, for example to pay for stock.

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29
Q

Businesses need cash to pay suppliers, overheads and employees

A

There are serious consequences if these groups aren’t paid. Suppliers may refuse to continue to supply a business, telephone or electricity supplies may be cut off and employees may refuse to work.

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30
Q

Businesses need cash to prevent business failure

A

When a business runs out of cash and cannot pay its debts it is said to be insolvent and can result in the business ceasing to trade.

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31
Q

At the end of a trading period a firm’s profit will not be the same at the value of the cash in the bank. Two reasons why this might be are:

A
  • A business may sell some products on trade credit. As a result customers may have bought the goods but not yet paid for them. These sales will increase profit but not the cash balance.
  • If the owners invest more in the business then the cash balance will rise but putting more money in the business has nothing to do with profit.
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32
Q

Cash flow?

A

The flow of money in and out of a business over a period of time

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33
Q

Cash inflow?

A

Money coming into a business, e.g, cash from sales and owner, bank loan

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34
Q

Cash outflow?

A

Money coming out of a business, e.g, wages, advertising, energy bills

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35
Q

How businesses monitor their cash flow/what is a cash flow forecast?

A

A cash flow forecast is a prediction of all expected receipts and expenses of a business over a future time period, which shows the expected cash balance at the end of each month

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36
Q

Net cash flow?

A

Total cash in - total cash out

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37
Q

Closing balance?

A

Net cash flow + opening balance

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38
Q

Why do businesses produce cash flow forecasts?

A
  • Helps a business find out if it will be short of cash
  • Enables a business to take action to prevent the business running out of cash
  • Cash flow forecasts are useful when applying for bank loans or overdrafts. If a business can show a sustained positive closing balance then the bank will be more confident that about granting a loan or overdraft because it is more likely it will be repaid.
  • A business can analyse its cash outflows and see how money has been spent. It may help a business identify ways of saving money and reducing costs.
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39
Q

What are the consuquences of a business running out of cash?

A
  • If the business does not have any cash, to pay bills, it will no longer be able to trade. The business is termed ‘insolvent’.
  • A ‘receiver’ is appointed to oversee the business.
  • The receiver will try to sell and find a buyer for the business
  • If no one will buy the business, the business will close down; all the assets will be sold.
  • The money from the sales of the assets will be given to the people the business owes money to.
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40
Q

Insolvency?

A

Inability to meet debts. When a business is not able to meet its financial commitments when they are due. The business has to stop trading by law.

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41
Q

Receiver?

A

A person who takes responsibility for an insolvent business and makes arrangements for the business’s debts to be repaid, for example by selling the business and its assets. The business is said to be ‘in receivership’.

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42
Q

Solutions to cash-flow problems

Delay payments to suppliers

A

Delay payments to suppliers to allow time for more money to be received from sales. Suppliers may not be happy and refuse to supply in the future

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43
Q

Solutions to cash-flow problems

Speed up cash inflows

A

Persuade customers to pay promptly, but customers may go to competitors who allow them more time to pay.

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44
Q

Solutions to cash-flow problems

Reduce cash outflows

A

Employ fewer staff, buy cheaper raw materials or buy stocks in smaller quantities. However, buying cheaper raw materials may be poor quality which results in customers being dissatisfied and lower sales in the future

45
Q

Solutions to cash-flow problems

Bank overdraft

A

A short-term, flexible bank loan, that can be obtained quickly but higher rates of interest are charged

46
Q

Solutions to cash-flow problems

Owners invest more money in the business

A

No interest is charged, but do the owners have the money available?

47
Q

Solutions to cash-flow problems

Advertising

A

Could help to increase sales by attracting more customer, but adverts will cost the business money, increasing cash outflows.

48
Q

Price?

A

This is the amount a business asks a customer to pay for a single product. When deciding on how much to sell a product for an entrepreneur will need to consider:
• How much competitors sell their products or services for
• How much it costs to make the product or provide the service

49
Q

Sales?

A

This is the number of products sold by a business over a given time period, e.g. month or year. It is stated in terms of the number of product sold and NOT in terms of money.

50
Q

Revenue?

A

Money from the sale of goods and services. It is also known as ‘turnover’. It is expressed in terms of money, £. It is calculated by:
Revenue = selling price x sales (number of units sold)

51
Q

Costs?

A

The money that has to be spent to start-up and run the business

52
Q

Fixed costs?

A

Do not change as output changes.

Rent, business rates, insurance

53
Q

Variable costs?

A

Change as output changes. If output increases, so do these costs, e.g. raw materials.
Variable cost = cost per unit x number of

54
Q

Total costs?

A

Fixed costs plus variable costs.

55
Q

Average cost?

A

The cost of producing a single unit of output.

Average Cost = Total Cost ÷ Quantity Produced

56
Q

Profit?

A

The money left over after all costs have been subtracted from revenue. It is calculated by:
Profit = Revenue – Total costs

57
Q

Break even point?

A

The level of output where total costs equals total revenue. Neither a profit or a loss is made

58
Q

Margin of safety?

A

Current output - breakeven output

59
Q

Break even output?

A

Break-even output=

Fixed Costs
______________________________

Selling price per unit – variable costs per unit

Where Contribution Per Unit = selling price per unit – variable costs per unit

60
Q

Selling price is increased…

A
  • sales revenue line gets cheaper

- BE point decreases

61
Q

Selling price is decreased…

A
  • sales revenue line gets flatter

- BE point increases

62
Q

Variable costs increase…

A
  • variable cost line gets steeper, so total cost line gets steeper
  • BE point increases
63
Q

Variable costs decrease…

A
  • variable cost line gets flatter, so total cost line gets flatter
  • BE point decreases
64
Q

Fixed costs increase…

A
  • fixed cost line gets higher, so total cost line is also shifted up
  • BE point increases
65
Q

Fixed costs decrease…

A
  • Fixed cost line falls, so total cost line shifts down

- BE point decreases

66
Q

Advantages of break-even?

A
  • It is quick to do - the break-even point and Margin of Safety can be established almost immediately. This means managers can take rapid action to reduce costs or increase sales if they need to increase their margin of safety and profits, thereby increasing the likelihood of business success.
  • Can be used to test whether a new business venture is likely to be profitable and therefore worthwhile.
  • It can be used to assess the impact of changes in variable costs, fixed costs and selling price on the break-even point and margin of safety
67
Q

Disadvantages of break-even?

A
  • Break-even charts assume the total revenue line is straight. This may not be the case if a business offers customer discounts for large orders.
  • It is only as accurate as the information on which it is based. If cost data is inaccurate this could lead to wrong conclusions and decisions being made.
  • Break-even charts assume the total cost line is straight. This may not be the case if a business benefits from purchasing economies of scale by bulk buying.
  • It assumes that a business will sell all the products it produces. This is unrealistic as businesses hold stocks of finished goods so they can meet increases in customer demand
68
Q

Sales revenue?

A

The money a business receives from selling its goods or services

69
Q

Cost of sales?

A

The direct costs of the business, The costs incurred in producing the goods or providing the service, e.g, raw materials

70
Q

Gross profit?

A

Sales revenue - cost of sales

71
Q

Over heads?

A

Indirect costs which cannot be identified with a particular unit of output. Incurred by the whole business, e.g, office staff salaries

72
Q

Operating profit?

A

Gross profit - expenses

73
Q

Statement of comprehensive income/profit and loss account?

A

-A financial statement that shows a firm’s income and expenditure and resulting profit or loss over a given period of time, usually a year. It contains the following in this order:

Revenue, Cost of Sales, Gross Profit, Administrative Expenses, Other Operating Expenses, Selling Expenses, Operating Profit, Finance Costs, Profit for the Year, Tax, Profit for the year after tax.

-Profit for the year after tax may be retained in the business for use in the future or distributed to shareholders as dividends.

74
Q

Investment decisions?

A

Businesses might invest to grow the business, e.g. by developing new products, buying new equipment or building factories. Businesses are more likely to invest if the Statement of Comprehensive Income shows profits are improving

75
Q

Cost analysis?

A

If costs have increased sharply between the previous and the current year then a business will want to know why and what type of costs have increased so it can take action to reduce costs and improve profits

76
Q

Forecasts of future profit?

A

Shareholders expect to be told how much profit a business expects to make in the future and a business can use current profits as a basis for this prediction.

77
Q

Making comparisons?

A

Investors might compare the statements of comprehensive income of different businesses to decide which to invest in and which are most likely to give the best return on their investment.

78
Q

The nature of profit and its importance?

A
  • Businesses exist to make a profit. It is the reward for individuals taking a risk to set up a business. If profits are not sufficient then an entrepreneur may decide to close the business.
  • The profit levels of an industry determine whether money flows into and is invested in an industry. For example social media is a growing area attracting investment whereas the production and sale of DVDs is declining (HMV has recently gone into administration).
  • Profit is a measure of judging how successful a business is. Businesses that meet customer needs at a price customers are prepared to pay and at the right quality will be most successful.
79
Q

Statement of Financial position (also called BALANCE SHEET?

A

An accounting statement showing an organisation’s assets, liabilities and capital at a single point in time.

80
Q

Assets?

A

Resources owned or used by a business e.g. buildings, equipment, stock

81
Q

Liabilities?

A

Debts of the business which provide a source of funds. Something that a business owes, e.g. loans, dividends

82
Q

Non-current assets?

A

Items owned and used by the business for more than one year. Are used by the business to help generate revenue, e.g. premises and equipment

83
Q

Current assets?

A

Assets that will be converted into cash within a year. They are shown in order of liquidity: Stock, Trade Receivables, Bank, Cash. Order of liquidity refers to the ease with which the asset can be turned into cash. Trade Receivables: Amounts of money that are owed to a business by its customers. They have purchased goods which are to be paid for at a later date.

84
Q

Current liabilities?

A

Money owed by a business - debts to be repaid within a year e.g. tax, money owed to suppliers.

85
Q

Net current assets?

A
  • Current Assets – Current Liabilities.
  • This shows working capital. Working Capital is the amount of money needed to pay for day to day trading. It is used to by resources and pay bills e.g. wages. Businesses may run short of working capital due to a fall in sales or if a business unexpectedly has to pay for things such as machinery breakdowns. Working capital can be improved by an overdraft or delaying payments to suppliers.
86
Q

Non-current liabilities?

A

Money owed by a business - debts that will be repaid after 12 months. e.g. bank loan.

87
Q

Shareholders’ Equity (also known as Capital and Reserves)?

A

The money put into the business by the owners. It includes share capital, retained profit and other reserves.

88
Q

Capital employed?

A

The amount the owners have invested in the business.

89
Q

On a statement of financial position for a limited company, the two numbers which balance are…?

A
  • Net Assets
  • Capital Employed
  • Net Assets = Non-Current Assets + Current Assets – Current Liabilities – Non-Current Liabilities

OR

  • Net Assets = Non-Current Assets + Net Current Assets
  • This makes sense because if a business buys a new asset, e.g. a vehicle, it will appear under non-current assets. However, finance will have to be raised to pay for this and this is shown on the other half of the balance sheet, under shareholders’ equity or non-current liabilities depending on the source of finance.
90
Q

The statement of financial position shows…?

A
  • The value of a business’ assets and liabilities.
  • What types of assets a business owns and how these have been financed.
  • How the business is funded (the balance between share capital and loans)
  • The amount of working capital a business has and whether it is sufficient to fund day to day trading
91
Q

Gross profit margin?

A

Gross Profit Margin % = Gross Profit x 100

Revenue

92
Q

Operating profit margin?

A

-Operating Profit Margin % = Operating Profit x 100
Revenue

  • The higher the percentage, the better the business is performing!
  • The operating profit margin shows how well a business controls its costs and overheads. An operating profit margin of over 10% indicates a business is performing very well. If there is a small difference between the gross profit margin and the operating profit margin this indicates that a business’ overheads are low and that it is controlling its costs.
93
Q

Mark up?

A

-Mark-up% = Profit per Item x 100
Cost per Item

-This shows the percentage profit made per item sold. Mark-up can also be used by a business to determine its selling price because it can enable a business to identify a price that covers costs and gives a profit.
Price = cost + (cost x percentage mark-up)

94
Q

Return on capital employed?

A

-Return on Capital Employed (ROCE) % = Operating Profit
————————- Capital Employed

  • Where Capital Employed = Shareholders’ Equity + Non-Current Liabilities
  • ROCE shows the profit of a business as a percentage of the amount of money (capital) invested to generate this profit. A business will look to increase the ROCE. It can also be compared with interest rates. If the ROCE is greater than the interest rate then the business can generate a greater return from investing in the business rather than keeping money in the bank.
95
Q

Current ratio?

A

-Current Ratio = current assets
current liabilities

  • It is suggested that a business should have a current ratio of between 1.5 and 2.
  • Less than 1.5 and a business may not have enough working capital and may struggle to pay current liabilities.
  • Greater than 2 and a business may have too much money that is tied up in current assets which could be used more productively.
96
Q

Acid test?

A

-Acid Test = current assets – stock
current liabilities

  • This is a harder test because stock is subtracted from current assets.
  • A business cannot use its stock to pay its debts and stock is the hardest current asset to convert into cash.
  • An acid test less than 1 means the value of its current assets minus stock does not cover its current liabilities so the business may not be able to pay its current liabilities.
97
Q

Liquidity?

A
  • This is concerned with how quickly assets can be turned into cash. It is important because without sufficient cash a business will not survive.
  • Non-Current Assets are not liquid assets because property and equipment can take a long time to sell.
  • Current assets are liquid assets and in order of liquidity (the least liquid first) they are stock, trade receivables and cash.
  • Stock is the least liquid current asset because it cannot be certain if or how much stock will be sold.
98
Q

Comparisons with previous years and or with other business organisations

A
  • The statement of comprehensive income and the statement of financial position shows the information for both the current year and the previous year. This means ratios can be calculated for both years and compared to see if the results of the ratios have improved or got worse.
  • Ratios can be calculated for different businesses in the same industry, e.g. supermarkets to understand how a business is performing compared to its competitors.
99
Q

Managers?

A
  • To prepare budgets and control cash flow

- Assess performance and set business objectives

100
Q

Employees?

A
  • Negotiate pay increases

- Assess their job security

101
Q

External shareholders?

A
  • To assess how well their investment is performing.
  • Should they continue to keep their shares or should they invest elsewhere?
  • How much dividend will they receive?
102
Q

Banks?

A
  • Should they lend business money?

- How likely is it that a business can repay a loan?

103
Q

Suppliers?

A
  • Should they give a business trade credit?

- How likely is it that a business will be able to pay for supplies at a later date?

104
Q

Competitors?

A

-Would it be a good decision to takeover another business?

105
Q

Tax authorities?

A

-How much tax, VAT and excise duties should a business pay?

106
Q

Funding?

A

If working capital is low a business may need to arrange an overdraft or chase-up trade receivables. If a business has a high value of retained profit a business could use this to fund growth instead of taking out a bank loan and paying interest.

107
Q

Cutting costs?

A

If there is a big difference between the gross profit margin and the operating profit margin this indicates that a business’ overheads are high and that it is not controlling its costs.

108
Q

Increasing profitability?

A

A business may compare its gross profit margin with its competitors. If the gross profit margin is small compared with competitors then a business may consider whether profit can be improved either by increasing prices or cutting direct costs such as raw materials.

109
Q

Investment decisions?

A

If the business is in a strong, stable financial position, it may be possible for the business to take a calculated risk and invest in growing and expanding the business.

Y11 BUSINESS (7 decks)

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