3.5 Financial Management

Question 1

CASH FLOW means

Answer 1

the money received by a business (‘inflows’) and the money paid by a business (‘outflows’). It mainly refers to money received and paid through a business’ bank account.

Question 2

REVENUE

Answer 2

means the total value of goods & services sold

Question 3

COST OF SALES

Answer 3

are the costs to the business of buying or making the goods or services that it has provided. These are the variable costs of the business, such as materials.

Question 4

OPERATING EXPENSES

Answer 4

are the fixed costs of the business (rent, salaries, etc.)

Question 5

OPERATING PROFIT

Answer 5

Gross profit-operating expenses

Question 6

Gross profit

Answer 6

Revenue-cost of sales

Question 7

Profit for the year

Answer 7

Operating profit + Profit from other activities – Finance costs (Interest) – Tax on profits

Question 8

RETURN ON INVESTMENT (expressed as a percentage)

Answer 8

Return (impact on profit) ÷ Cost of the investment x 100

Question 9

BUDGETS

Answer 9

are planned levels of income, expenditure or profit over a period of time.

Question 10

VARIANCES

Answer 10

are the differences between budgeted figures and actual ones.
They can be either ADVERSE or FAVOURABLE.

Question 11

ADVERSE VARIANCE

Answer 11

causes the actual profit of a business to be lower than budgeted.
Revenue is lower than budgeted or costs are higher than expected.

Question 12

FAVOURABLE VARIANCE

Answer 12

causes the profit of a business to be higher than budgeted. Revenue is higher than budgeted or costs are lower than budgeted.

Question 13

Benefits of producing budgets:

Answer 13

Budgeted levels of income and provide sales targets, which can motivate employees to generate sales

● Budgeted levels of expenditure can help to control costs

● Budgeted calculations of profit can support applications for bank loans or investors

Question 14

CONTRIBUTION PER UNIT

Answer 14

means the amount each unit sold contributes towards the fixed costs of a business.

Question 15

Contribution per unit =

Answer 15

Selling Price – Variable Costs per Unit

Question 16

TOTAL CONTRIBUTION=
Two ways of working it

Answer 16

Contribution per unit x Number of units sold

Revenue – Total variable costs

Question 18

Formula for profit from contribution

Answer 18

Total contribution – Fixed costs

Question 19

BREAK-EVEN POINT

Answer 19

is the level of sales where revenue is exactly equal to total costs

Question 20

Calculation of break even point

Answer 20

Fixed costs/contribution per unit

Question 21

The purposes of it(break even point)

However,

Answer 21

calculating a break-even point are to set sales targets, to assess the viability of a business, and to help obtain a bank loan.

the forecast figures for costs and selling price may not be accurate, without market research we don’t really know whether the BEP is viable, and most businesses sell a variety of products at different prices.

Question 22

MARGIN OF SAFETY =

Answer 22

Actual level of sales – Breakeven level of sales

Question 23

Revenue =

Answer 23

Selling price x Number of units sold

Question 24

GROSS PROFIT MARGIN=

Answer 24

Gross profit ÷ Revenue x 100

Question 25

PROFIT FROM OPERATIONS MARGIN=

Answer 25

Operating profit ÷ Revenue x 100

Question 26

PROFIT FOR THE YEAR MARGIN =

Answer 26

Profit for the Year ÷ Revenue x 100

Question 27

NET CASH FLOW =

Answer 27

Total inflows – Total outflows

Question 28

CLOSING BALANCE =

Answer 28

Opening balance + Net cash flow

Question 29

OPENING BALANCE=

Answer 29

The previous month’s closing balance

Question 30

How to improve cash flow

Answer 30

Increasing inflows by getting customers to pay more quickly ● Decreasing outflows by taking longer to pay supplier

Question 31

RETAINED PROFITS

Answer 31

are the profits kept in a company after tax and dividends have been subtracted. However, they can only be used as a source of finance if they are CASH

Question 32

SHARE CAPITAL.

Answer 32

is money received from the shareholders, who own a company and vote whether to reappoint the directors at the AGM. They receive dividends depending on the profitability of the company

Question 33

VENTURE CAPITALISTS

Answer 33

provide funds for small & medium sized firms who are considered too risky by banks. They usually provide a combination of loan and shares.

Question 34

ADVANTAGES OF USING SHARE CAPITAL OR VENTURE CAPITAL

Answer 34

No repayments, which helps cash flow The amount paid in dividends depends on how well the business has done No security is needed

Question 35

DISADVANTAGES OF USING SHARE CAPITAL OR VENTURE CAPITAL

Answer 35

Profits have to be shared for as long as the other investors own the shares You can lose control of the business if you sell more than 50% of it

Question 36

BANK LOAN

Answer 36

is a fixed amount that must be repaid, plus interest, over a stated amount of time in equal monthly instalments. Security must be provided.

Question 37

ADVANTAGES OF USING A BANK LOAN

Answer 37

The repayments only last for a fixed period of time You don’t lose any control of the business

Question 38

DISADVANTAGES OF USING A BANK LOAN

Answer 38

Repayments must be made, which can damage cash flow The interest is an additional fixed cost, which reduces profits You may need to be able to offer security

Question 39

CROWD FUNDING

Answer 39

means inviting a large number of investors to each provide a relatively small loan, amount of share capital or donation. The large number of inventors means that the total raised is relatively large.

Question 40

OVERDRAFT

Answer 40

means that the bank account is allowed to have a negative balance. Interest is paid of the exact amount overdrawn, and security may be required.

Question 41

DEBT FACTORING

Answer 41

means obtaining finance from a specialist factoring company against unpaid sales invoices.

Question 42

METHODS OF IMPROVING CASH FLOW

Answer 42

METHOD DIFFICULTY Reducing the amount of inventory held Could run out of inventory and let down customers Ensuring that credit customers pay on time Can be difficult to enforce Selling more goods for cash (maybe offering discount) and less on credit Discount allowed to customers is an additional cost, which decreases profit Extending credit terms with suppliers Suppliers may not be willing to provide longer credit terms. Arranging or increasing an overdraft facility The interest is an additional cost, which decreases profit. The bank may not allow it. Debt factoring (if a business is selling on credit) Factoring companies charge a high rate of interest, which decreases profits.

Question 43

METHODS OF IMPROVING PROFITS BY INCREASING REVENUE

Answer 43

METHOD DIFFICULTY Change the selling price It may cause revenue to decrease It may cause revenue to decrease (depends on the price elasticity of demand) Advertising and other promotional methods It is an additional fixed cost, which may actually cause profits to fall. Improve or change the products The initial cost of improving products may damage cash flow Expand – open new branches or break into new regions/countries The initial cost of expansion damages cash flow

Question 44

METHODS OF IMPROVING PROFITS BY DECREASING COSTS

Answer 44

METHOD DIFFICULTY Make some staff redundant (if they are not needed) May decrease the level of customer service. The redundancy payments damage cash flow. Hold less inventory (reducing storage costs, wastage, etc.) Could run out of inventory and let down customers Buy in bulk (to get discount) Bad for cash flow. More danger of inventory being damaged or not sold Find cheaper suppliers Quality of your goods might decrease. Automation – investing in technology to replace some of the workers The initial cost damages cash flow. Move to a cheaper location Fewer customers (if a retailer) Finding a new workforce (if a manufacturer) Increase the efficiency of workers (lowering unit costs of production) Initial training is an additional cost, and also damages cash flow