Business management

Finance 3.1 - 3.9

Capital expenditure

Refers to finance spend on fixed assets for long term function that can be used repeatedly. They provide collateral for the business, add production capacity, improve efficiency and can replace damaged equipment.

Revenue expenditure

Refers to the expenses incurred for the daily operations of a business and spent on payment of indirect costs. It can generate value for the business and helps motivate workforce and improve productivity.

Personal funds

Entrepreneurs own savings. Useful for start ups. Usually insufficient.

Retained profit ‘

Keeps after paying dividends to shareholders. Used for capital expenditure. Doesn’t incur interest charges

Sale of assets

Sale of dormant assists to raise finance.

Share capital

Money raised for selling shares. Huge amount of finance. Don’t have to pay back

Loan capital

Obtained from commercial lenders. Paid back in instalments.

Mortgages and business development loans

Mortgages- loan for purchase of property. Interest is payable and assets are at risk if the business does not make repayments as planned BDL- highly flexible made to specific needs of borrower to expand business.

Debentures

Long term loan certificates issued by business. interest payments. Debenture holders have no ownership. Increases gearing ratio because of long term debt.

Overdrafts

overdraw on it’s bank account. Suitable for large cash outflow problems. High rate of interest, flexible repayable on demand.

Trade credit

Pay back on a later date. Helps Manage cash flow and inventory. Interest charges

Crowdfunding

Raising finance from large number of individuals to finance a business venture. Helps start ups raise money.

Leasing.

Between leasing company (lessor) and customer (lessee). Hires assets from lessor. Repairs and maintenance us the responsibility of the lessor. Classified as a business expense so it reduces tax.

Hire purchase

Pay creditors in instalments. Defaults on agreement-asset can be repossessed. Interest charges apply.

Micro finance providers

Entrepreneurs of small low income areas. Enables disadvantages members to gain finance. Job creation, helps accessibility. However, there is limited finance

Considerations before investing

Return on investment, business plan, track record, people.

size and status of firm

Easier to raise finance from wider sources from large and establish firm. Large firms can obtain cheaper finance due to EOS

Duration

Whether you need short or long term finance

Business angels

Wealthy individuals who invest their own money to provide finance for firms unable to secure sufficient finance. Owner might loose control if bought out.

Fixed costs

Pay regardless of production or sales. Independent of the level of output.

Variable costs

Change in proportion with level of output. No production -VC are 0

Direct costs

Attributed to individual project without which costs would not be incurred.

Indirect costs

Cannot be traced to production or sales

Not indentured with business activity.

Revenue

Money that business earns from sale of goods and services

Revenue streams

Money coming into a business from various business activities

Advantages and limitations or a p&l

• shows profit/loss after all costs and expenses are accounted for

• Based on historical performance

• Window dressing

Limitations of balance sheets

• Only accurate estimate figures

• Financial position can vary in different periods

• Not all assets included - intangible assets , value off human capital

Intangible assets

Non physical fixed assets, intellectual property rights

Limitations of final accounts

• qualitative factors ignored

• Does not allow anaylsis over time

• Historical/past financial data used

Depreciation

Fall in asset value over time

1) wear and tear - used repeatedly

2) obsolescence - newer/better products in market. Out of date

Straight line depreciation

• simple to calc and understand

• Not realistic as it drops the same amount every year

• Does not account for loss of efficiency over time

Units of production method

Better insights to true running cost and time it takes to fully deplete

Purpose of ratio analysis

Examine financial position - liquidity or profitability

Aids decision making for investors

GPM

raising sales revenue

• raising selling price of products

• Improve marketing strategies

Reducing direct costs

• changing suppliers

• Reduce staffing costs

Profit margin

raising sales revenue

• raising selling price of products

• Improve marketing strategies

Reducing direct costs

• changing suppliers

• Reduce staffing costs

ROCE

Should exceed interest rates that banks can provide

Improved by boosting profits

Current ratio

Should be between 1.5 to 2.0

• allows safety net as it’s not possible to sell current assets quickly

• Likely to be sufficient working capital to grow and invest

Less than 1.0 - jeopardise survival

Causes and improvements of CA

causes

• too much cash in firm

• Too many debtors

• Too much stock

Improved by

• raising value of CA

• Reducing value of CL

Acid test ratio

Should be 1:1 or might experience working capital difficulties

Improved by raising CA and reducing CL

Stock turnover improvement

• holding lower stock levels

• Getting rid of obsolete stock

• Only keeping best selling products

Debtors days

Too high - chance of liquidity problems

Too low - customers may seek suppliers with better trade credit terms

Improve debtor days

• impose sub hangers on late payers

• Refuse businesses unless payment is done

• Give incentives such as discounts

Improve creditor days

• develop closer relationships with suppliers to extend time period

Gearing ratio

Higher the gearing ratio - business incurs higher costs- limits profit

Working capital

Funds for daily running to pay the immediate spending such as raw materials

Insufficient working capital leads to no liquid assets to fund everydaY

Too much working capital - opportunity cost

Strategies to improve cash flow ( reduce cash outflows)

• seek alternative suppliers

• Better stock control

• Leasing rather than purchasing

• Reduce expenses

Strategies to improve cash flow ( improve cash inflows )

• righter credit control

• Cash payments only

• Improve product portfolio

Investment appraisal

Quantitative techniques used to calc the financial costs/benefits of a investment decision

A and d of payback period

• useful for liquidity problems

• Compare projects for best option

• Seasonal fluctuations

• Only short term approach

• No qualitative factors

A and d of ARR

• easy comparisons for estimated returns

• Ignores timing of NCFs prone to forecasting errors

Profit centre

Incurs both costs and revenues

Allows to indenitfy the areas that make the most and least revenues

Leads to Improved cost control and higher profits

Cost centre

Incurs costs that are attributed to activities of that division and helps managers to have better cost control

A and D of cost and profit centres

• managers can identify areas of weaknesses

• All costs can be allocated across various cost/profit centres

• Adds pressures and burdens to employees

• Like likely to focus on social responsibility or ethical objectives as that takes compliance away and reduces profits

Favourable variance

Adverse variance

Discrepancies are financially beneficial

When discrepancies are financially detrimental

Importance of budgets

• planning and guidance

• Coordination

• Control

• Motivational

Limitations of budgets

• inflexible

• Ignores qualitative factors

• Tendencies for managers to overestimate

risks associated with high gearing ratio

• financial risk

• rising interest risks are problematic

• reduces profitability

ways to improve gearing ratio

• looking for free sources of finance

• don’t pay dividends

• reduce long term borrowings