IB Business and Management Finance

Capital

The money invested into the business and is used to purchase a range of assets including machinery and stocks.

Revenue Expenditure

Refers to the purchase of items such as fuel and raw materials that will be used up within a short period of time

Capital Expenditure

The spending of a business on non-current assets which will be used for more than one year, such as production equipment and vehicles

Statement of Financial Position (Balance Sheet

A financial statement that records the assets (possessions) and liabilities (debts) of a business on a particular day at the end of an accounting period.

A statement of profit or loss

A financial statement showing a business's sales revenue over a trading period and all the relevant costs incurred to generate that revenue

Personal Funds (For Sole Traders)

A source for sole traders to use their own savings as cash for the business.

Sale of Assets

Businesses can raise cash by selling assets they no longer require

Retained Profit

The profit from previous years that has not been paid to shareholders as dividends

What are the 3 internal sources of finance?

1. Retained Profit

2. Personal Funds

3. Sale of Assets

Share Capital

Is finance raised by a company from selling shares in its business to shareholders

Loan Capital

Is money that is borrowed over a medium or long period of time. Examples of loan capital include bank loans and mortgages,

Collateral

A form of security required by banks before agreeing on a loan

Mortgages

are long term (up to 50 years) loans used to purchase land or property. The land or property is used as security by the lender against any failure to repay

Debentures

Debentures are long term loans with fixed rates of interest. Land or property is often used as security for this type of loan capital

Overdrafts

Permits an individual or a business to borrow money up to an agreed limit at any time

Trade Credit

Is a period of between 30 and 90 days given by suppliers before payment is due for goods and services.

Crowdfunding

A source of finance that entails collecting relatively small amounts of money from a large number of supporters.

Leasing

Includes paying for assets over a period of time without ever owning the asset.

Microfinance providers

Give financial services to poor and low income clients

Business Angel

A person who has a large personal. fortune and is willing to use some of this money to support risky ventures

Venture Capital

is funds (in the shape of share and loan capital) that are advanced to businesses which are thought to be relatively high-risk

Costs

are expenses that a business has to pay to engage in its trading activities

Fixed Costs

Costs that do not vary rergardless of the output produced.

Variable Costs

Costs that are directly associated with the level of output of a business

Total Costs

fixed costs + variable costs

Direct Costs

Costs that can be directly attributable to the production of a particular product and can vary with the level of output

Indirect Costs

Overheads that cannot be attributed to the production of a particular product and relate to the business as a whole

Revenue

The income a business receives from selling its goods or services

Revenue Streams

A business's earnings from its full range of trading activities including renting assets such as property

What are some examples of revenue streams

1. Revenue from advertising

2. Dividends

3. Donations

4. Earnings from bank deposits

5. Subscription fees

6. Merchandise

7. Sponsorship

Total revenue

The income a business earns from all of its acitivites added together

Profit

The extent to which a business's total revenue exceeds its total costs over a period of trading

Loss

The amount by which a business's total costs exceed its total revenue over a period of trading

Gross Profit

A business's sales revenue minus their total costs of sales

Profit before interest and tax

Gross Profit - Expenses

Profit before tax

Profit after interest rate

Profit for period

Profit before paying out dividends

List the statement of profit or loss in order

1. Sales Revenue

2. (Cost of Sales)

3. Gross Profit

4. (Expenses)

5. Profit before interest and tax

6. (Interest)

7. Profit before tax

8. (Tax)

9. Profit for period

10. (Dividends)

11. Retained Profit

Statements of profit or loss for non-profit enterprises

Terminology

Surplus = Profit

Deficit = Loss

No tax

Assets

Items owned owned by a business such as cash in the bank

Stocks

are the raw materials and other items necessary for production to take place. They also include finished products that have not yet been sold

Debtors

Are people and organizations that owe the business money.

Liabilities

Represent money owned by a business to individuals. suppliers, financial institutions and shareholders

Creditors

Are organizations such as suppliers to which the business owes money

Non-Current Assets

Assets that a business expects to retain for one year or more.

Current Assets

The category of asset is likely to be converted into cash before the next statement of financial position

Working captial

Current assets minus current liabilities

Net assets

total assets - total liabilities

Retained Profit

Profits that have been earned during previous trading period and that have not been paid to the owners of the business. They are sometimes called retained earnings.

Depreciation

The reduction in the value of a non-current asset over a period of time.

Residual Value

The value of a non-current asset at the end of it's working life

Straight line method of depreciation

reduces the value of a non current asset by the same amount for each year

(Cost of asset - residual value)/Working life in years

Unit of use method of depreciation

Reduces the value of a non-current asset in any year according to the volume of production undertaken by the asset

(The number of units produced/life in number of units) x (Initial cost - residual value)

Tanglible assets

Assets that have a physical existence and are included in a statement of financial position

Intanglible assets

are items owned by a business which do not have a physical form.

Raise Cash Inflow

Raise cash inflow

Tighter credit control

Cash payments

Change of pricing policy

Broaden product portfolioMarketing planning

3.5

good luck

Ratio analysis

A technique for analysing a business's financial performance by comparing one piece of accounting information with another

Types of ratio

Profitability

Liquidity

Efficiency

Gearing

Gross Profit Margin

Gross Profit Margin = (Gross profit x 100)/Revenue

Strategies to increase GPM

Increase sales revenue

Lower cost of sales

Net Profit Margin

Profit Margin = (Profit before interest and tax x 100)/Sales Revenue

Strategies to improve NPM

Lower Overhead

Negotiate Rental Agreement

Lower supplier cost

Return on Capital Invested Ratio (ROCE)

ROCE = (Profit before interest and tax x 100)/Capital Employed

Capital Employed

Equity + Non current liabilities

Strategies to improve ROCE

Change Prices

Reduce Costs

Reduce Capital Employed

Current Ratio

Current assets/current liabilities

The Acid Test

(Current Assets - Stock)/ Current Liabilities

Ways to improve Acid Test Ratio and Current Ratio

Selling assets or agreeing on more long-term loans

Delaying capital payments that would require cash payments

Paying off current liabilities

Negotiating trade credit

3.6

Efficiency Ratios

Look at how well a firm's financial resources are being used.

Stock Turnover Ratio

Cost of sales / average stock held

Ways to improve Stock Turnover Ratio

Holding Lower levels of stock

Dispose of stocks that are slow to sell

Reduce the range of products being sold, only keeping the ones with greater turnover

Debtor Days Ratio

(debtors / total sales revenue) x 365

Creditor Days Ratio

(Creditors / Cost of Sales) x 365

Gearing Ratio

non-current liabilities/capital employed x 100

High Geared Ratio

>50%

Inadequate long-term liquidity - very risky

More dependency on long-term sources of borrowing

High Gearing Impact

More vulnerable to increases in interest rates

If there is recession, loan repayments are still high but sales will most probably fall

Financiers are less likely to lend to highly-geared firms

Vulnerable to rival takeovers

3.7

Cash vs. Profit

Having cash or cash flows IS NOT the same as having profit

Good cash flow, poor profits - cash is coming from sources other than sales revenue (e.g. loans, capital investments, etc.)

Poor cash flow, good profits - sales are good, but payment of loans, capital equipment, poor collections practices, and early payments of supplies can bring cash flow down

Cash flow forecasts

Financial document that shows expected monthly cash inflows and outflows

Cash Inflow

Money received

Cash Outflow

payment of bills, usually itemized expenses

Net Cash Flow

The difference between cash inflows and cash outflows.

Constructing cash flow forecasts

Get the Opening Balance

Amount of cash at the beginning of the trading period

Add Cash inflow from sales + other income

Add itemized cash outflow of expenses including: stocks, labor, etc.

Closing balance is the opening balance of the next month

Causes of cash flow problems

Overtrading

Overborrowing

Overstocking

Poor credit control

Seasonal or unforeseen causes

Relationship between investment, profit, and cash flow

Investments are cash outflows done to improve the processes, products, or services of a company.

Purchasing assets with the goal of yielding future financial benefits.e.g. better equipment, more seats

Cash flows are the flow of cash going in or out of a company's finances. Investments should bring in higher cash inflows in the future ideally.e.g. more customers, more sales

Profits If the cash inflows and other revenue sources are higher than all cash outflows and expenses, then a company has a profit

This is the ultimate goal of a company

Dealing with Cash Flow Problems

Lower Cash Outflow

Preferential credit terms

Alternative suppliers

Stock control

Lower overhead expenses

Alternative Finance Sources

Overdraft

Sale and leaseback

Debt factoring

Sale of fixed assets

Other measures

Contingency funds

Develop wider customer base

Request for partial payment

Pay large bills by installments

Improve quality

Limitations in Cash Flow Forecasts

Poor marketing forecasts

Workforce conflicts or motivational issues

Operations/Manufacturing delays

Business competition

Changing trends and demand

Economic changes and external shocks

3.8

Investment Appraisal

Evaluation of investments using quantitative techniques (looking for potential net gains)

Qualitative issues that can be faced in making an investment

Objectives of the firm

External costs and benefits

Current or expected state of the economy

Past experiences

Corporate image: Whether the investment will conflict with a company's values

Exogenous shocks

Unexpected economical change (e.g. fall in stock prices, rise in prices of housing, etc.)

Cash Flows

Estimated profits over the lifetime of the investment

Cumulative cash flow

Cash flow based on total cash is subtracted by total cash out for a specific duration of time

Cumulative cash flow = Total cash out - Net cash flow up to that period

Payback Period (PBP)

Time it takes for an investment to repay the initial outlay

Calculate month of payback

(Income required / Contribution per month)

Contribution per month

(Cash flow for next year / 12)

Advantage

Simple and quick

Firms can identify how long they can recoup and whether or not it will break-even on a purchased asset

Compare different investment projects

Assess projects that yields quick returns

Short term, so calculations are less prone to forecasting errors