Higher Business - Management of Finance

Based on Scottish Higher Business Management course specification (2024) . Contains the vocabulary, meanings, advs & disadvs for all key terms in the Finance unit!

Cash Budgeting

A cash budget shows expected receipts and payments on a monthly basis to help assess potential cash flow problems.

Cash Budgeting - Benefits

• To plan for the future (forecasting)

• Financial or goal-oriented target setting

• Evaluation and analysis of performance

• Delegation of financial responsibility

• Data and information collection

• To aid in decision making

Cash Budgeting - Helps managers with

• Holding their decisions accountable

• Checking income and expenditure levels

• Long-term planning

• Comparing predictions with actual results

Cash Flow Problems - Reasons

• Spending too much cash on stock that’s not sold

• Allowing customers too long to pay their debts (credit)

• Borrowing too much finance at high interest rates

• Not receiving enough time to pay suppliers

• Owners taking too many drawings out of the business

• Low sales

• Purchase of fixed assets

Cash Flow Problems - Impact

• Stock that isn’t being sold can build up resulting in reduced profits, Increases storage costs and heightened risk of product obsolescence

• May not have enough money to pay for products, bills and wages

• Can push business into debt if loans/interest isn’t payed back

• No Stock = No business coming in

Cash Flow Problems - Solutions

• Selling Assets

  Brings in extra money from the sale and money isn’t used on the maintenance of spare assets

• Crowd Funding

  Brings in voluntary money, given from the public to help the business, doesn’t need to be repaid

• Reduce the amount of drawings

  More money can be spent on the business improving supplies, devices, venue and even wages which in addition would increase morale

• Overtime Ban

  Less money would be spent on overtime wages which can instead go into paying off loans/debts

• Apply for Government Grant

  Provides a lump sum of money that doesn’t need to be payed back

• Moving Premises for cheaper rent

  Less money spent on rent which can be put towards: Supplies, advertisement, repaying loans, etc

Financial Statements

Include:

• Income statements

• Statement of financial position

Statement of Financial Position

Shows the values of the business at a precise point in time.

Includes:

Assets

Liabilities

Capital

Working Capital

Liquidity

Statement of Financial Position - Assets

What the business owns

Fixed Assets = Have a lifespan of more than a year

Current Assets = Lifespan of less than a year (they’re constantly changing)

Statement of Financial Position - Liabilities

What the business owes

Current Liabilities = Trade creditors, Overdrafts and short-term loans

Long-term Liabilities = Take longer than 1 year to pay back

Statement of Financial Position - Capital

Provided by the owner and treated as being owed to the owner

Profits result in increased capital

Drawings result in decreased capital

Reserves are monies retained by the business

Statement of Financial Position - Working Capital

Shows current assets minus current liabilities

If a business has too little working capital then they’ll have difficultly paying off short-term debts

If a business has too much working capital then they’re not using their resources properly

Statement of Financial Position - Liquidity

Shows us whether a business has enough assets to cover its debts.

Turns assets into cash to pay off debts

Stock is the hardest to turn into cash

Income Statements

An income statement shows how much profit/loss is made by a business

• Gross Profit

  The profit from buying and selling goods only

  Sales Revenue - Cost of Sales

• Net Profit

  The profit after all expenses are taken off

  Gross Profit - all expenses

Sources of Finance - Retained Profits

Internal Source

• Profits kept by the company for future events

• Doesn’t have to be paid back

• Limited amount available

Sources of Finance - Selling Assets

Internal Source

Money raised by selling off an asset no longer needed.

• The business will have no costs to repay

• May free-up space within the organisations

• Brings large amounts of capital into the business

• The businesses assets are reduced, which could make it difficult to secure future finance.

Sources of Finance - Overdraft

External Short-term

Is an agreement with the bank that the business can draw from its current account up to a certain amount more than it has in it.

(Interest is only charged on the amount of the overdraft)

• Simple to arrange interest for days applicable

• Easy access to extra money in case of emergency

• Can be expensive if used for a long time due to interest charges.

• If overdraft exceeds the limit, facility may be withdrawn.

Sources of Finance - Trade Credit

External Short-term

Negotiating a longer period of time between receiving goods from suppliers and having to pay for them.

• Can improve their cash flow position

• Prompt payment discount lost

• If you don’t make the payment in time a late fee may be added

Source of Finance - Debt Factoring

External Short-term

A specialist business collecting unpaid debt fees.

• The factor, chases up unpaid debt, saving the company time & money

• Factors tend to be interested in only large outstanding debts as they can earn more profit.

• The business doesn’t receive the full outstanding debt.

Sources of Finance - Government Grant

External Short Term

A sum of money given to a business by the Government.

• A grant doesn’t need to be repaid. It’s usually given to the business in one lump sum.

• Usually only given once to new or starting up businesses

• It could be tied to a specific project that the business must undertake.

Sources of Finance - Leasing

Medium term

Renting equipment or premises rather than having to raise their finances to buy these outright.

• The equipment can be changed on a regular basis and will therefore be up-to-date.

• Over a long period of time it can become expensive. The equipment is not owned by the business and is therefore not an asset to them.

Source of Finance - Hire Purchase

Medium-term

Acquiring an asset on credit followed by fixed payments. After the last instalment purchaser owns asset.

• The cost of the purchase is spread over a period of time, making it possible to purchase fairly expensive items.

• High rates of interest can make this an expensive way of financing the purchase of assets.

Source of Finance - Issuing Shares

Long term

Capital raised by selling shares.

• Large amounts of capital can be raised.

• Shareholders benefit from limited liability

• The administration costs involved in ‘issuing shares’ can be expensive

• The selling price of shares is subject to demand and the selling price can rise or fall.

Source of Finance - Bank Loan

Long Term

Borrowing money from the bank which is to be re-paid over time with interest.

• Easy to budget as set cost monthly

• Easy to arrange

• Must pay interest

• These interest rates may skyrocket if not paid back on time.

Source of Finance - Mortgages

Long Term

A loan secured on property

• Repayment is over a long-period of time.

• Fixed interest rates can be arranged so that the organisation knows what it’s monthly payments will be for the foreseeable future.

• Failure to meet monthly repayments will result in the property being reposed.

• When interest rates are not fixed, monthly repayments can vary greatly depending on current interest rates.

Source of Finance - Crowd Funding

Long term

When a business uses social media or crowdfunding platforms online. It’s a method of raising finance through the collective efforts of friends, family, customers and investors.

• Huge amounts of finance can be raised and it doesn’t need to be repaid.

• No added interest.

• Need public interest and support to be successful.

Source of Finance - Venture Capitalist

Long term

Provides loans to those businesses that banks or other lenders consider to be too risky. In return for lending the money, they acquire a share in the business for financial return.

• Those businesses with a risky credit rating can secure finance from a reputable source.

• Not suitable for short-term financial requirements.

• Part-ownership of the business could be requested in exchange of finance.

Purpose of Ratio Analysis

• Compare the performance of the business with previous years

• Compare the performance of a business to that of its competitors

• Compare against industry averages

• Highlight areas of the business that need attention

• Highlight trends to aid future decision-making

Limitations of Ratio Analysis

• Historic information

• Don’t take into account external factors

• Don’t take into account internal factors

• Don’t take into account product development

• Can only compare with competitors of the exact type and size

Profitability Ratios

Measure how profitable a business is.

• Gross profit percentage

• Net profit percentage

• Return on capital employed

Gross Profit Percentage

(gross profit / sales revenue * 100)

• Measures the percentage of profit made from buying and selling.

Improvements

• Increase sales revenue

• Purchasing cheaper goods

Net Profit Percentage

(Net Profit / Net sales * 100)

• This measures the percentage of profit made once expenses are deducted from gross profit.

Improvements

• Reduce expenses

• Increase sales revenue

• Improve gross profit to have a knock-on effect

Return on Capital Employed

(Profit for the year / equity *100)

The measurement of the percentage return on the capital invested in the business.

Improvements

• Attempt to increase profit for the year

Liquidity Ratios

Measures organisation’s ability to pay their short-term debts.

• Acid test ratio

• Current ratio

Current Ratio

(Current assets / current liabilities)

• Measures the ability of a business to pay back short term debts.

• Over 2:1 is ideal, as it proves the business has twice the current assets as current liabilities and a health cash flow.

Improvements

• Improve net profit (reduce cost of expenses)

Acid Test Ratio

(Current assets - closing inventory / current liabilities)

• Measures the ability of a business to pay back short-term debts in a crisis situation.

• By removing inventory from the equation, the business can assess its cash flow without including the least liquid current asset.

Improvements

• if a business has less than 1:1 it must secure more current assets.

Efficiency Ratios

Measure how well a business uses its resources.

• Rate of Stock Turnover

Rate of Stock Turnover

(Cost of sales / average inventory)

• Measures the amount of time a business re-stocks its inventory during the year.

Improvements

• Buy in smaller quantities of stock more frequently

• If result is too low they should use JIT to avoid overstocking, sell off excess stock or/and negotiate sales or return with suppliers

Technology - Spreadsheets

Can be used to prepare financial statements:

• Greater accuracy using formula

reducing margin for error

• Formula can be replicated, saving time.

• Charts and graphs can be made easily, allowing the information to be analysed and presented

Technology - PowerPoint

Can be used to engage audience when presenting information through the use of animation and colour.

Technology - Email

Can be used to circulate financial information quickly.

Technology - Internet Banking

Can be used to make payments or check balances quickly

Technology - Sage Software

Can be used to keep track of payments and income

Can be used to send invoices to customers

Technology - EFTPOS

Electronic Funds Transfer Point of Sale

Can be used to receive money from customers instantly e.g. through contactless payment. This reduces the need for handling of cash.

Uses of Financial Information in Business

Controlling costs and expenditures

Forecasting trends

Planning for the future

Monitor performance

Who Uses Financial Information

Shareholders

Employees

Investors & potential investors

Local community

Creditors

Trade unions

Government

Economists

Customers

Users of Financial Information - Managers/Owners

• Require measures of profit to evaluate the effects of past decisions

• Evaluate how well they achieved the organisational goals

• Acts as a guide assist in the decision-making process for the next financial period.

• Need to know patterns of cash flows, both historical and current

• Be able to predict and maintain liquidity and credit worthiness

• Need to have detailed information about the organisation’s assets and liabilities to assist in the control of them.

• Uses this information to control the actions of employees.

Users of Financial Information - Shareholders

Interested in the profits as this may influence dividend payments.

Users of Financial Information - Employees

To see if bonuses may be paid

To satisfy themselves that there is job security

Users of Financial Information - (Potential) Investors

Will want information on past performance and present finical position of an organisation to attempt to predict the future returns on capital investment.

Users of Financial Information - Local Community

Success of organisation may bring more jobs to the area and boost the local economy.

Users of Financial Information - Creditors

Asses the amount of security for the deb owed to them.

Interested in the organisation’s ability to generate funds to repay capital amounts outstanding and to repay on a regular basis, any interest owing.

Users of Financial Information - Trade Unions

Re-present group of employees and will try to negotiate the best deal for their members.

Users of Financial Information - Government

Must be provided with certain information by law regarding the financial position of an organisation.

Users of Financial Information - Customers

Interested in:

• Harmful and dangerous products

• Monopolistic profits

• Pollution

• Offensive advertising

• Foreign control

Limitations of Financial analysis

• Financial statements of historic

• Using different methods of stock valuation can result in different value figures from company to company

• Unless looking at percentage figures, the impact of inflation is not reflected in comparative factors

• International variations

• Valuing intangible

Limitations of Financial analysis - Not included in financial data

• Morale/staff turnover

• Product portfolio

• Abilities of staff

• Research and development

• Competition of market

• Marketing techniques used

• Organisation structures

• Social concerns