1.3 Putting A Business Idea Into Practice

Question 1

Aim

Answer 1

Business aims are the long-term aspirations of an organization.

Question 2

Objectives

Answer 2

Business objectives are specific, measurable, achievable, relevant, and time-bound targets (SMART targets) that must be achieved to realise those aspirations.

Question 3

Financial objectives

Answer 3

Survival: Most crucially in the first year. 60% of all start-ups in the UK fail within their first three years.
Sales: A business must get customers who will buy its product to earn an income for its owners.
Profit: The sales revenue received must be more than the costs to make a profit.
Market share: The percentage of the total market revenue that a single firm has. If market share is increasing it means that the firm is competing effectively.
Financial security: This is where a business and its owners can pay all the overheads (bills), make a profit, and have some in reserve to pay for unexpected emergencies.

Question 4

Non financial objectives

Answer 4

Social entrepreneurship: Many entrepreneurs aim to address social issues. Helping others still needs to have a financial objective behind it for a business to succeed and be sustainable.
Personal satisfaction: This may be gained from doing what the entrepreneur wants to do i.e. starting a business which aligns with personal passions.
Challenge: This could be setting up something that nobody else has thought of and can link with personal satisfaction. It may be a chance to prove to others (or to the entrepreneur) that something can be done.
Independence and control: The entrepreneur may want to control their own time and the direction of their business. Independence enables people to do things their way which can be very motivational.

Question 5

Sales revenue

Answer 5

Sales revenue is the value of the units sold by a business.
Sales revenue = quantity sold x price

Question 6

Costs

Answer 6

Businesses incur range of costs from purchasing raw materials, paying staff salaries and wages and paying utility bills.
They can be split into the following - fixed costs, variable costs and total costs.

Question 7

Fixed costs

Answer 7

Fixed costs are costs that do not change as the level of output changes.
Examples include rent, management salaries, insurance and bank loan repayments.

Question 8

Variable costs

Answer 8

Variable costs are costs that change directly with the output. These increase as output increases. Examples include raw material costs and wages of workers directly involved in the production.

Question 9

Total costs

Answer 9

Total variable cost = variable costs x quantity
Total costs = fixed cost + variable costs

Question 10

Reducing costs

Answer 10

An important way to improve profit is to reduce costs.
Businesses must consider carefully the impacts of reducing costs on customer service, quality and speed of delivery.

Fixed costs may be reduced by relocating to a cheaper premise or reducing worker’s salaries.
Variable costs may be reduced by sourcing cheaper materials by buying in bulk or outsourcing distribution and packaging to a third party business.

Question 11

Profit

Answer 11

Profit is the money left over after all the costs have been accounted for. If the costs are greater than the sales a company is making a loss.
Gross profit = revenue - costs
Net profit = gross profit - (operating expenses + interest)

Question 12

Profit margin

Answer 12

A profit margin is the amount by which sales revenue exceeds the costs.
Profit margins can be compared to previous years to better understand business performance.

Question 13

Gross profit margin

Answer 13

This shows the proportion of revenue that is turned into gross profit and is expressed as a percentage.
(Gross profit / sales revenue) x 100 = gross profit margin

Question 14

Net profit margin

Answer 14

The net profit margin shows the proportion of sales revenue that is turned into net profit and is expressed as a percentage.
Net profit margins = (net profit / sales revenue) x 100

Question 15

Break even point

Answer 15

the break even point is a useful metric to help a business understand how many units it needs to sell before it starts making a profit.
Break even point in units = fixed cost / (selling price - variable cost)

Question 16

Margin of safety

Answer 16

The margin of safety is the amount by which the number of units sold is greater than the break even point.
Margin of safety = current sales - break even point

Question 17

Aims and objectives

Answer 17

Industry - Businesses operating in different industries will have different objectives and aims.
Size - The size of a business can also influence its aims and objectives. A small business may focus on survival and achieving sustainable growth, while a larger corporation may prioritise product diversification and market dominance.
Culture - Each business has its unique culture, which reflects its values, beliefs, and overall vision. This culture can impact the organization’s aims and objectives, as well as the strategies that the business uses to achieve them.
The ownership structure of a business can influence its objectives.

Question 18

Cash flow

Answer 18

Cash is the money that a business can spend immediately (it doesn’t include money that a business owes or is owed). Cash flow is the amount of money that is coming in and out of a business and the timings of these cash transfers.

Question 19

Cash inflow and outflow

Answer 19

Cash inflows is the cash coming into the business.
typical inflows include receipts from sales, money received from a new bank loan, money from sales of an asset.

Cash outflows is the cash going out of the business.
typical outflows include payments on raw materials, paying staff wages and salaries, paying utility bills.

Question 20

Net cash flow

Answer 20

Net cash flows = cash inflows - cash outflows.

Question 21

Opening and closing balance

Answer 21

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 is the amount of cash that a business finishes trading with.

Question 22

Cash flow forecasts

Answer 22

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.
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.

Question 23

Cashflow problems

Answer 23

A business having persistent negative cash flows is unlikely to be sustainable. The business will eventually run out of money and will not be able to pay for salaries, rent or raw materials. In the short-term, negative cash flows can cause problems with stakeholders and cause business failure (insolvency).

Question 24

Consequences of cash flow problems

Answer 24

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.
If a business runs out of cash, it may not be able to pay its suppliers.
This could create a temporary halt in production. It may also damage the relationship between the business and suppliers.
Creditors are organisations (or people) that have loaned a 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.

Question 25

Solutions to cash flow problems

Answer 25

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. 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. 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. Finding other sources of finance can provide a firm with the money they need to overcome a liquidity problem. Increasing sales, chasing customers that owe money and selling assets can all increase cash inflows.

Question 26

Short terms sources of finance

Answer 26

Short-term financing refers to obtaining financial resources to cover immediate needs that usually have a term of one year or less.

Question 27

Overdraft

Answer 27

An arrangement with the Bank for business current account holders to spend more money than it has in their account. Pros - A limit is agreed and interest is charged only when a business ‘goes overdrawn’ Offers significant flexibility and aids cash flow Cons - An overdraft may be ‘called in’ if the bank is concerned about a business's ability to repay what it owes Interest on overdrafts tends to be higher than on other loans

Question 28

Trade credit

Answer 28

An agreement is made with the business suppliers to buy raw materials, components and stock which are paid for at a later date (typically 30 to 90 days). Pros - Trade credit is usually interest-free A business can increase its stock without having to immediately pay for it which can significantly enable a positive cash flow if the stock is sold before payment becomes due. Cons - Suppliers may prioritise delivery to customers who have the shortest repayment dates Cash needs to be carefully managed to ensure the business has the money available to pay its suppliers on the agreed date

Question 29

Long term sources of finance

Answer 29

Businesses can use the capital (money) to initially start up, to fund new investments for growth or to support a business if it is struggling.

Question 30

Retained profit

Answer 30

The profit that has been generated in previous years and not distributed to owners is reinvested back into the business. Pros - Retained profit is a cheap source of finance. This is because interest is not paid on retained profit. Therefore, the business would not experience an increase in costs. Retained profit does not dilute the ownership of the business. This is because the owner(s) keep full control of all decisions made since no new shares are issued. This may lead to decisions being made quicker in the business. Cons - The opportunity cost of investing the money back into the business is that shareholders do not receive extra profit for their investment.

Question 31

Personal savings

Answer 31

This is personal money that is invested by the owner of a company. It is most relevant for start-up companies, in which the entrepreneur has saved up to fund their business venture. A downside is that it can be very risky for an entrepreneur to put a significant amount of their personal savings into a business.

Question 32

Venture capital

Answer 32

Some specialist venture capital businesses or successful entrepreneurs can be approached to invest in higher-risk businesses for a portion of the company in in return. Pros - A business rejected as high-risk by banks may be able to access large amounts finance Venture capitalists often provide business advice. Cons - Most venture capitalists demand a stake in the business and expect to have a say in how the business is run.

Question 33

Crowd funding

Answer 33

Crowdfunding allows businesses to access finance provided by a large number of small investors on online platforms such as Kickstarter. Pros - The Business has to attain the target amount before any funds are released. Investors are often attracted by incentives such as a sample or early access to a product. Cons - Businesses need to provide a persuasive business plan to convince individuals to invest in their product as they will be competing with many other projects online.

Question 34

Share capital

Answer 34

Share capital is finance raised from the sale of shares in a limited company. Pros - Large amounts of money can be quickly raised from wealthy investors Shareholders who buy a large number of shares may also bring and share expertise, which can be beneficial to the business. Cons - Shareholders are the owners of shares and they are entitled to a share of the company’s profit when dividends are declared Shareholders usually have a vote at a company’s Annual General Meeting (AGM) where they can have a say in the composition of the Board of Directors.

Question 35

Bank loans

Answer 35

A sum of money is borrowed from the bank and repaid (with interest) over a specific period of time. Pros - Bank loans are usually unsecured and are typically repaid over two to ten years. Interest rates are fixed for the term of the loan so repayments are made in equal instalments - which helps with business planning. Cons - Interest is payable and the business assets are at risk if the business does not make repayments as planned.