Business: Finance

What is the role of finance function?

1. Calculate profit & loss using SR & PC

2. Forecast cashflow + decide if finance is needed

3. Manage payments

4. Arrange finance (loans etc)

5. Calculate break even output needed

6. Calculate ARR

What is the definition of finance?

The money raised and used by a business

WHat is the definition of the finance function?

The financial department, usually only found in larger businesses as small businesses usually employ a firm of accountants to help with their finance function.

What is the definition of financial information?

Includes details of profits, loss, cashflow, break-even, profit margin and average rate of return. This info is used in business decision making.

Why do businesses need to raise finance?

1. Establishing a business - Pay for upfront costs e.g. rent, furniture & machinery

2. Funding expansion - Pay for a larger factory, machinery, more stock or materials to support an increase in scale

3. Recruitment - Recruitment is always needed & wages / salaries need to be paid (start up, expansion, staff leaving)

4. Marketing - Campaigns, ads & public reations (maintaining a good image)must be funded

5. Running the business - Buying materials, paying for utilities, paying wages

What are all the sources of finance (9)

1. Owners capital

2. Retained profit

3. Sale of assets

4. Overdraft

5. Trade credit

6. New partner

7. Loan

8. Shar issue

9. Crowdfunding - money donated by investors / customers

What are the Advantages and Disadvantages of Owners Capital?

Adv	DisAdv
No need to repay	Owner risks savings
No interest	May not have enough
Doesn’t affect ownership or control

What are the Advantages and Disadvantages of retained profit?

Adv	DisAdv
No need to repay	May not have made profit yet
No interest	Owner won’t keep profit as income

What are the Advantages and Disadvantages of Sale of assets?

Adv	DisAdv
No need to repay	May be difficult to sell
No interest	No longer have the benefit of the asset
Good if selling old machinery or stock	May take time to sell

What are the Advantages and Disadvantages of Overdraft?

Adv	DisAdv
Meets short-term cashflow problem	Interest charged daily
Interest paid only on what is owed
Only repaid when not needed / business closes

What are the Advantages and Disadvantages of Trade Credit?

Adv	DisAdv
Have goods to sell before paying for them via credit period (30/60/90 days)	Goods must be paid for even if they don’t sell
No interest if paid back on time	Interest charged on late payment
Can help with cashflow problems

What are the Advantages and Disadvantages of Taking on a New partner?

Adv	DisAdv
May bring new skills	Share ownership, control & profits
Don’t need to repay	Sole traders become partnerships
No interest

What are the Advantages and Disadvantages of a loan?

Adv	DisAdv
Paid in fixed sums monthly over period of time	Interest
Money is available immediately	May need to give the lender security

What are the Advantages and Disadvantages of a Share issue?

Adv	DisAdv
New investors can contribute lots of money	Share control, ownership & decisions
Don’t have to repay	Pay dividends
No interest	Shares only sold by PLC or LTD

What are the Advantages and Disadvantages of Crowdfunding?

Adv	DisAdv
Can contribute lots of money via loans, donations or investing	Interest if money raised through a loan
Don’t need to repay	Shared ownership if money is from investors
No interest

What types of finance are short term?

• Owners capital

• Trade credit

• Sale of assets

What types of finance are mid term?

• Owners Capital

• Sale of assets

• Bank loan

• Crowdfunding

What types of finance are long term?

• Owners capital

• Sale of assets

• Retained profit

• Bank loan

• Crowdfunding

• New Partner

• Share issue

What is revenue and the formula?

The money coming into the business through sales

Quantity sold x Selling price = Total Revenue

What are the different types of costs?

Variable costs - Change depending on output of business e.g. materials, tax, wages

Fixed Costs - Don’t change even if output changes and usually paid monthly e.g. rent, salaries

Total Costs - FC + TVC

What are the types of profit and the formula?

• The total amount of money made left from sales after deducting costs

• Profit is only made if there is more revenue than costs.

• If there is less revenue than costs, you have made a loss.

• Gross Profit = Sales (TR) - Cost of sales (TVC)

• Net Profit = Gross profit - Operating costs (FC)

• Total Revenue - FC - TVC = Profit

What are the benefits of keeping costs low?

• Better profit margin

• Reduce sales price → more sales

• Lowers the breakeven → make profit quicker

Profit Margins

Gross profit margin = Gross profit / Total Revenue x100

Net Profit margin = Net profit / Total Revenue

What is ARR and the formula?

Average Rate of Return is used for decision making as it determines the profitability of an investment

ARR= Avr annual profit / initial capital outlay x100

Advantages and Disadvantages of ARR

Adv	DisAdv
Easily understood	Ignored time-value of money (Inflation)
Easy to calculate	Limited to one metric
Quick comparison of investments	Reliance on estimates
Useful in decision making
Long-term performance evaluation

What is Break-Even and what is the formula?

The point when the total revenue equals the total costs. You are not making a profit or a loss. Calculates how much each unit contributes to initial costs and long-term profits.

Fixed Costs / Selling price - VC = contribution

(Per unit)

Advantages and Disadvantages of Break-even

Adv	DisAdv
Quick, simple & helps decision making	Only a forecast
Predicts level of risk	Not good for services as prices vary
Shows potential profitability	Assumes all products made are sold
Shows no. of units to sell before making a profit	Costs can change

Label this break even graph

Uses of Break Even

Limitations of Break Even

What is cashflow forecast?

A Statement showing the expected flow of money into and out of a business over a period of time

What are the uses of a cashflow forecast?

• Planning tool, get a loan

• Anticipate shortfall of cash & arrange finance

• Provides targets (enough cash to pay bills in a shortfall)

May not always be accurate:

Sales may not be as high as expected, higher costs or lower prices

What is liquidity?

The business is able to pay its bills