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business > 3.6 Finance > Flashcards

3.6 Finance Flashcards

1
Q

Finance

A

The capital needed to start up and run a business.

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2
Q

Why do businesses need finance?

A

• Rent or buy building
• Advertising
• Stock

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3
Q

Internal sources of finance
Definition

A

Capital found inside the business.

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4
Q

Internal sources of finance
Examples

A

• Retained profit
• Owners capital
• Share capital
• Selling assets and leaseback
• Redundancies

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5
Q

Retained profit
Advantage and disadvantage

A

+ No interest
- Opportunity cost
- Might not be available

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6
Q

Owners capital
Advantages and disadvantages

A

+ No interest
- Opportunity cost
- Risk own money if unlimited liability

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7
Q

Share capital
Advantages and disadvantages

A

+ Raise finance quickly and easily for PLCs
+ Limited liability
- Loose control

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8
Q

Sale and leaseback
Advantage and disadvantages

A

+ No interest
- Can undervalue asset

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9
Q

External sources of finance
Definition

A

Capital found outside the business.

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10
Q

External sources of finance
Examples

A

• Family and friends
• Loan
• Mortgage
• Overdrafts
• Trade credit
• Hire purchase
• Government grants
• New share issue

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11
Q

Loan
Advantages and disadvantages

A

+ Large amount of capital
- High interest

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12
Q

Mortgage
Advantages and disadvantages

A

+ Can purchase expensive property/land without having capital upfront
- High interest

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13
Q

Overdrafts
Advantages and disadvantages

A

+ Immediate emergency finance
- High interest

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14
Q

Trade credit
Advantages and disadvantages

A

+ Flexibility - time to sell products
- Requires good relationship with supplier

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15
Q

Hire purchase
Advantages and disadvantages

A

+ Spread the cost if don’t have immediate finance
- You won’t own it so can’t make decisions on it
- Cost more overall

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16
Q

Government grants
Advantages and disadvantages

A

+ Doesn’t have to be payed back
- Not a lot of money

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17
Q

New share issue
Advantages and disadvantages

A

+ Give a lot of money and advice
- Loose control

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18
Q

What factors influence the sources of finance chosen?

A

• The businesses profitability
• The amount of finance needed
• How risky the business is judged to be
• The amount of personal finance available

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19
Q

Cash flow

A

The amount of money moving in and out of a business on a day to day basis.

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20
Q

Importance of cash flow?

A

1) Cash to pay its bills on time to suppliers.
2) Enough money to pay workers
3) Enables the business not to borrow

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21
Q

Cash flow statement

A

A financial account that record the receipts and payments of a business (previous years).

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22
Q

Receipts

A

Money into the business.

Sales
Loan from a bank

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23
Q

Payments

A

Money out of the business.

Wages
Purchase of stocks

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24
Q

Net cash flow

A

The difference between the cash coming into the business and the cash flowing out.

Receipts - payments

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25
Q

Liquidity

A

If a business experiences problems where they do not have enough cash to cover their payments they cannot continue to trade.

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26
Q

What causes cash flow problems?

A

• Poor cash flow management/inexperienced managers
• Business is making a loss
• Relying on trade credit
• Giving customers too much trade credit

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27
Q

How can cash flow problems be resolved?

A

• Rescheldue payments (to suppliers, from customers)
• Cut costs (hold less stock, cheaper suppliers)
• Use an overdraft / other source of finance
• Sell assets / sale and leaseback

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28
Q

Profit

A

Total revenue - Total costs

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29
Q

Cash flow

A

Cash coming in and out of a business.

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30
Q

Creditor

A

Someone that you owe money too.
Suppliers

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31
Q

Debtor

A

Someone that owes you money.
Customers

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32
Q

Why are cash and profit different?

A

1) Profit exists in financial records.
2) Cash is the physical existence of cash.

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33
Q

Insolvency

A

Negative cash

34
Q

Closing balance

A

Net cash flow + opening balance

35
Q

Why does revenue not equal profit?

A

The business may have costs to pay with their revenue so it can’t all be kept as profit.

36
Q

Break even

A

The level of production (output) at which a businesses total costs exactly equal total revenue.
Total revenue = Total costs

37
Q

Why is break even important?

A

• Determines when you will start to make a profit
• Can allow the business to chose between different projects or products, which one breaks even first.

38
Q

Fixed costs on a Breakeven chart

A

Fixed costs stay the same and are therefore a straight horizontal line.

39
Q

Variable costs on a Breakeven chart

A

Variable costs change in relation to the number of items produced and therefore start at 0 and slope diagonally.

40
Q

Total costs on a Breakeven chart

A

Total costs are fixed costs plus variable costs and therefore start at the point of fixed costs and then slope upwards at the same gradient as variable costs.

41
Q

When does Breakeven output occur?

A

When total costs equal exactly total revenue.

42
Q

Margin of safety
Definition

A

Measures the amount by which a businesses current level of production exceeds its Breakeven level of production.

43
Q

Margin of safety
Equation

A

Current output - Breakeven output

44
Q

Breakeven analysis

A

Breakeven analysis is a simple tool and makes assumptions.
• Fixed costs stay the same
• Variable costs per unit do not change as output change
• Output is all sold
• Selling price remains the same as output changes

45
Q

Breakeven point
Equation

A

FC / SPPU - VCPU

46
Q

Breakeven analysis advantages

A

• Easy to calculate
• Quick to produce
• Can be shown to a bank to support an application for a loan
• “What if” analysis can be used to see the effect of changes in selling price and costs.

47
Q

Breakeven analysis disadvantages

A

• If a firm sells products at different prices it’s difficult to use
• If the data is not accurate the break-even point will be incorrect
• Predicted sales levels might not be met

48
Q

Investment project

A

When a business invests in an asset in the hope of making a profit from its use.

49
Q

Investment project examples

A

1) New machinery
2) New building/land
3) New vehicles
4) New products

50
Q

Average rate of return
Definition

A

An investment appraisal technique (assessing wether an investment is worthwhile).

51
Q

Average rate of return
Calculation

A

Average annual profit / Initial investment cost X 100

52
Q

Average annual profit

A

Total profit - initial investment / number of years

53
Q

Why is ARR a useful investment tool?

A

• Business investment projects need to earn a satisfactory rate of return which can be seen with ARR.
• ARR provides a percentage return which can be compared with a target return.
• ARR looks at the whole profitability of the project.
• Focuses on profitability - a key issue for shareholders

54
Q

Why is ARR not a useful investment tool?

A

• Does not take into account cash flow - only profits (may not be the same thing).
• Takes no account of the time value of money (inflation).
• Hard to gauge your profits that far in advance.

55
Q

Income statements

A

A record of the costs and revenues of a business over a period of time (1 year).

56
Q

Gross profit

A

Sales turnover - cost of sales

57
Q

Net profit

A

Gross profits - overheads

58
Q

How does an income statement help a business?

A

1) If a business is making a loss it shows the directors what is causing it.
2) Assess business performance in terms of profitability
3) identify which costs need to be reduced

59
Q

Sales turnover

A

SPPU x Output

60
Q

Retained profit

A

Net profit - (tax + dividends)

61
Q

Depreciation

A

The fall in value of an asset over time.

62
Q

Which is depreciation important for an income statement?

A

1) It is an expense as the asset that you bought is not worth the same so it has lost you money.
2) To recognise that a business must ‘write off’ things that change in value.

63
Q

How do Businesses use financial information to analyse performance?

A

• Compare with previous years
• Conparison with competition
• Comparison to targets

64
Q

Statement of financial position

A

Part of business accounts that records assets and liabilities.

65
Q

Assets

A

Resources a business owns.

66
Q

Non current assets

A

Resources used often that are difficult to turn into cash. Usually owned for a long period of time (+1yr)

Building, furniture, equipment, shareholders funds, investments, vehicles, brand name.

67
Q

Current assets

A

Short term assets that can be turned into cash within 12 months.

Cash at the bank, stock, raw materials, petty cash.

68
Q

Liabilities

A

Resources/items it owes.

69
Q

Non current liabilities

A

Debts due to be repaid after more than 12 months.

Long term loans, mortgage.

70
Q

Current liabilities

A

Debts due to be repaid within one year.

Bank overdraft, dividends.

71
Q

Capital/financed by

A

The money to fund the assets must have come from somewhere (capital employed = the investments)
Capital is funds provided by the owners/shareholders.
Capital is also provided from previous sales in the form of retained profit/reserves.

72
Q

Net current assets

A

Current assets - current liabilities

73
Q

Net Assets

A

Non current assets + Net current assets - Non current liabilities

Should equal total equity.

74
Q

How can a statement of financial position be used to assess performance?

A

• To see if assets are more than liabilities.
• To see wether you have enough current assets to keep you going in the short term.
• If you have a good amount of net assets.

75
Q

Why does the statement of financial position balance?

A

If a business purchased some new vehicles, they would have to raise the finance somehow.

76
Q

What is the purpose of the statement of financial position?

A

Measures the worth or value of a business.
1. Judge if it is safe to lend money to the business.
2. Judge if it is safe to invest in that business.

77
Q

Why is net current assets an important calculation?

A

Net current assets (working capital)
Working capital = Current assets - Current liabilities

• Pay for day to day running day to day.
• Useful if no trade credit.
• Can tell if firm has liquidity problem.

78
Q

Profitability

A

Analysing how profitable a business is.

79
Q

Profitability ratios

A

These ratios are ways of measuring how profitable a business is so that it’s performance can be assessed. All the information is found in the income statement.

80
Q

Gross profit margin

A

Gross profit/Sales X 100

• Expressed as %
• The higher the better
• The purpose of this ratio is to show what percentage of turnover is represented by gross profit (or how many pence out of every £1 of sales is gross profit)

  • Ignores overheads
    + Useful to assess control direct costs and ability to max sales.
81
Q

Net profit margin

A

Net profit/Sales X 100

• Expressed as %
• The higher the better
• The purpose of this ratio is to show what percentage of turnover is represented by net profit (or how many pence out of £1 of sales is net profit).

+ Best measure of quality of profit.
+ Sales turnover measures scale.

82
Q

Interpreting ratios

A

• Compare to the businesses target for that margin.
• Compare to previous years.
• Compare to the margin for other similar businesses.

business (8 decks)

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