BUSINESS A-LEVEL - THEME 2

Key terms for theme two of business a-level course

Economic Variables

Features of an economy which have an affect on business and consumers (e.g unemployment, inflation and exchange rates)

Internal Finance

The raising of finance/capital from within the business. (E.g Personal savings, retained profit, selling of shares)

Personal savings

Also called owners capital. A source of internal finance which is provided by the business’s owner

Retained profit

Profit kept overtime which is reinvested into the business

Sale of Assets

A type of internal finance involving the selling of assets which belong to a business

Bank Loan

An external method of gaining finance where money is borrowed from a bank which will be paid back with interest

Business angels

Individuals who invest into a business in exchange for a stake in shares

Crowd funding

An external source of finance where a large number of individuals provide funding for a business or it’s project. Usually in return for shares, free products or discounts

External finance

Money raised from outside business

Grant

A sum of money given by a government or other organisation. It doesn’t need to be repaid or have interest charged.

Leasing

A contract which acquires the use of resources such as property or equipment

Loan

An external source/method where money is borrowed, it is usually repayable after a fixed term of 12+ months

Overdraft

When a business has a negative balance in their bank account because the amount withdrawn is greater than their current balance

Peer-to-peer funding

When a person lends money to other individuals or business via online transactions

Trade credit

When a firm receives stock/inventory/raw material from a supplier, which doesn’t have to be paid until later

Share capital

The finance raised through a business issuing/selling shares

Venture Capital

An external source of finance where shares are sold to a small number of investors in return for capital interjection into the company

Liability

The obligations/responsibilities/debts which fall upon the business and its owners

Limited liability 

The obligation of a shareholder/investor for their debts of a business is limited to the value of their investment

Unlimited liability

The obligation of a business owner to cover ALL debts of the business

Business plan

A document giving details of a variety of aspects about the business in order to provide a strategic look at the business and to attract investors. It contains details such as the product, costs, revenues, cashflow forecasts

Cash flow

The movement of cash into and out of a business over a period of time

Cash inflow

The flow of cash into a business

Cash outflow

The flow of cash out of a business

Cashflow Forecast

The predicted flow of cash into and out of a business over a period of time

Closing Balance

Cash left in the account at the end of the month.

Net Cashflow

The difference between cash flowing in and out of a business over a period of time

Opening Balance 

Cash in bank at the start of the month

Net cashflow (formula)

Total Cash Inflows - Total cash outflows

Closing Balance (formula)

Net-Cashflow + Opening Balance

Consumer Trends

Habits or behaviour of consumers in the use of goods and services

Economic Uncertainty

When firms/consumers are unable to predict their future sales/income and costs

Sales Forecast

A prediction of the expected level of sales volume/revenue for a business for a future period

Average Cost

The cost of producing one unit

Average Cost (Formula)

Total costs/Output

Fixed costs

Costs that do not changes when output/sales changes

Revenue

The amount of income for a business generated from it’s sales.

Revenue (Formula)

Selling price x Quantity sold

Total costs

Total fixed costs + Total variable costs

Variable costs

Costs that vary according to the level of output

Sales Revenue

The total income a business generates from selling its core products or services over a specific period

Sales Volume

The volume of the units sold by a business

Fixed Costs

Costs which don’t change with output

Total Variable Costs (formula)

Variable costs x Quantity

Variable Cost per unit (formula)

Total variable cost / Quantity

Break-Even

The level of output where the total revenue is equal to total cost

Unit Contribution

The difference between the selling price and the variable cost per unit

Contribution per unit (formula)

Selling Price - Variable cost per unit

Total Contribution (formula)

Contribution Per Unit X Quantity of units sold

Margin of safety

The difference between the current/planned level of output/sales and the break even level of output

Budget

A financial plan of income and expenditure prepared/agreed in advance. Often used to estimate income, expenditure

Purpose of Budgeting

• Planning and Monitoring

• Control

• Coordination and communication

• Motivation and efficiency

Historical Budgeting

A system of Budgeting based on previous data, adjusted for inflation and planned events

• Quick + simple process

• Assumes all business conditions are unchanged

Zero- Based Budgeting

A system of budgeting where no money is allocated for costs/spending unless justified by the budget holder.

• Long process

• If done properly its more accurate than Historical budgeting

• Requires negotiation skills

Fixed Budgeting

The budget holder must stick to their plans

Flexible Budgeting

Allows budgets to be altered in response to significant changes in the economy

Variance Analysis

Shows the difference between budgeted and actual figures, it can be calculated at the end of a financial period, once actual figures are known.

Variance formula

Actual Budget - Expected Budget

Favourable Variance

Positive variance = resulting in higher profits (e.g lower costs than budget)

Adverse Variance

Negative Variance = Results in lower profits (e.g higher costs than budgets)

Advantages of Budgeting

• Controlling and monitoring costs

• ‘Reviews’ the business and allows time for corrective action

• Emphasis and clarifies responsibilities of budget holders

• Makes sure that capital is usefully employed

• Enables responsibility to be delegated without losing control

• Helps coordination + communication

• Provides clear targets

• Motivates the budget holder

Disadvantage of Budgeting

• If set incorrectly it can be demoralising

• If too inflexible the business may suffer

• Budget can lose importance if adverse variance

• Resentment from some personnel if lack of involvement

Assets

Items of value owned by the business that can be used to generate income

Current Assets

Items that will be converted into cash inflows within one year. (e.g stock, debtors and cash)

Non-Current Assets

Items that the business will use to generate sales for a period in excess of one year (e.g Machinery, vehicles, buildings)

Current Liabilities

Debts to be paid within a year (e.g overdrafts, trade credit)

Non-Current Liabilities

Debts that are due in over one year’s time (e.g Mortgage, bank loans)

Liquidity

The extent to which a business has sufficient cash or equivalent current assets to pay it’s debts as they fall due

Working Capital

The amount of money required for the day2day running of a business

Statement of financial position

A statement showing the financial structure of the business, containing information required to draw conclusions about the liquidity of the business

Ways to increase inflows

• Introduce a new source of finance

• Use of overdraft facilities

• Encourage cash sales

• Sale of stock

• Sale and leaseback assets

Ways to reduce outflows

• Extend trade credit with suppliers

• Reduce inventory levels

• Reduce costs

• Reduce dividend payments

Trade Payables

Amounts a business owes to its suppliers for goods/services purchased on credit

Trade Receivables

Amounts owed to the business by its customers for goods/services sold on credit

Acid Test Ratio (Formula)

Current Assets - Inventory / Current liabilities

Current Ratio (Formula)

Current Assets / Current Liabilities

Acid Test Ratio (Interpretation)

• A level of 1:1 is ideal

• Anything less than 1:1 indicates a struggle to pay debts

• Varies in different industries

Current Ratio (Interpretation)

• If the ratio is between 1.5:1 and 2:1 then liquid resources are sufficient

• If below 1:5 then the business may have insufficient cash to cover debts

• A ratio of above 2:1 can mean that too much money is used unproductively and could be better allocated elsewhere

How to improve liquidity

• Reduce the credit period offered to customers

• Introduce new capital and reduce drawings from the business

• Sell assets and lease fixed assets instead

• Ask suppliers for an extended repayment period

• Make use of overdraft facilities or short-term loans

• Sale of excess stock

Working Capital (Formula)

Current Assets - Current Liabilities