Component 1

budget

budget

a financial plan for the future that sets out targets for sales revenue and targets for expenditure (to cover costs)

5 purposes of budgets

- control of costs - avoid departments overspending
- monitoring of expenditure - expenditure can be monitored against budget
- motivation - can set clear sales/spending targets
- communication - can support the objectives of the business which is communicated to staff
- co-ordination - helps managers develop a view of the whole business and its projected profit/loss at the end of the year

5 limitations of budgets

- planned figures can be accurate - future is unpredictable
- costly and time consuming - opportunity costs
- conflict between managers - may feel that their budget is too low
- over-ambiguous targets - may occur which could be demotivating
- can be restrictive - opportunities cannot be acted on due to insufficient funds

3 factors that determine importance of budgets

- experience/skill of workers drawing up budget
- flexibility to take advantage of opportunities and deal with emergencies
- frequency of reviewal/updates to keep up with dynamic economy/market- experience/skill of workers drawing up budget
- flexibility to take advantage of opportunities and deal with emergencies
- frequency of reviewal/updates to keep up with dynamic economy/market

cash flow

the flow of money into and out of a business

3 sources of cash inflow

bank loans, cash sales, credit sales

3 examples of cash outflows

suppliers, bills, wages

cash flow forecast

a prediction of all expected cash flowing in and out of a business on a month-by-month basis for a period of time and the expected cash balance at the end of every month

cash flow deficit

cash outflows exceed inflows = negative cash flow

cash flow surplus

cash inflows exceed outflows = positive cash flow

net cash flow

total cash inflows minus total cash outflows

closing balance

opening balance + net cash flow

opening balance

the closing balance of the previous month ( or money invested into business for a new business)

3 causes of cash flow problems

- unexpected fall in demand - e.g. recession (decreases cash inflow)
- unforseen expenditure - e.g. unexpected machine breakdowns (increases cash outflow)
- overtrading - e.g. expanding too quickly with large outgoings with a delay before sales income (increases cash outflow)

3 methods of improving cash flow + evaluation of each

- improve revenue by increasing marketing to boost sales
pro: increases customer awareness
HIDO: finance available
- cutting costs to save money
pro: more finance available
HIDO: negative effects e.g. fall in quality
- finance the shortfall through borrowing e.g. arrange or extend overdraft
pro: short capital boost
HIDO: must be able to pay it back

3 advantages of cash flow forecasts

- give advance warning of cash flow shortages
- help to ensure there is always cash to pay expenses e.g. wages, suppliers
- help managers control the finance of business - prevents overspending

3 disadvantages of cash flow forecasts

- sales figures are often optimistic - demotivation if not reached
- costs are often underestimated, especially by new businesses
- events can occur that change the projected cash flow figures

how does cash flow differ from profit

cash flow is not the same as profit due to the timings of cash receipts/expenditure. eg a business may sell goods on credit - this immediately increases the profit figure for that financial period as a sale has been made but the cash will not flow into the business until later. Hence a profitable business may become bankrupt/insolvent due to cash flow problems

sources of finance

the options available to a business when seeking to raise funds to support future actions

one reason why a start-up business requires finance

raising sufficient capital to establish the business

one reason why an established business requires finance

to fund growth or implement a new stratergy eg relocation

internal sources of finance

from within the business

external sources of finance

from outside the business

bank loan

external. A banks lends money to a business on the provision that they make regular repayments over the agreed term, with a charge for interest.

advantage of bank loans

loans can be repaid over time making monthly repayments more manageable

disadvantage of bank loans

interest is charged which increases business costs

what is a bank loan used for

short term expenses (eg paying suppliers) and long term expenses (eg expansion)

type of business a bank loan is suitable for

all businesses, although new businesses, high-risk businesses and businesses that already have a lot of loans may struggle

share capital

external. Limited companies can sell shares to raise finance

advantage of share capital

large amounts of finance can be raised

disadvantage of share capital

selling of shares dilutes control of business

what is share capital used for

large expenditure eg expansion

type of business share capital is suitable for

limited companies - ltd/plc

venture capital

external. A cash rich investor provides a business with finance for an agreed share in the business

advantage of venture capital

venture capitalists often provide advice as well as finance as they are usually highly experienced

disadvantage of venture capital

some venture capitalists may demand a high share of ownership, reducing ownership share for the entrepreneur

what is venture capital used for

start-up, as well as expansion

type of business venture capital is suitable for

new entrepreneur, SMEs that are expanding

leasing

external. A business pays a monthly fee in return for the use of an asset

advantage of leasing

affordable option for businesses who cannot afford to buy the assets in one purchase

disadvantage of leasing

more expensive than buying in one purchase as the leasing company charge for spreading the cost overtime

what is leasing used for

renting fixed assets eg machinery, computers, vehicles

type of business leasing is suitable for

all, but established businesses find it easier to obtain

overdraft

external. Businesses can spend more money than they have in their current accounts

advantage of overdraft

enables a business to continue operating and paying bills

disadvantage of overdraft

high interest rate charges have to be paid and this increases costs (higher on overdrafts as unsecured borrowing)

what are overdrafts used for

day to day expenses eg paying suppliers, wages, energy suppliers

type of business overdraft is suitable for

all businesses, but established usinesses will be able to access larger overdrafts and arrange lower interest charges as lower risk

trade credit

external. A business receives goods from a supplier but pays for them later

advantage of trade credit

eases cash flow as a business has the chance to sell the goods before paying for them

disadvantage of trade credit

late payment incurs a penalty, increasing business costs

what is trade credit used for

buying stock eg raw materials

type of business trade credit is suitable for

all, but new firms may find it difficult to obtain as they are seen as too high risk

debt factoring

external. A business sells the debt that is owing to them to a factoring company, often owned by the main banks

advantage of debt factoring

cash immediately comes into the business from the sale of the debts thereby increasing any cash flow problems, the chasing of the debt then falls to the factoring company thereby removing this job from the business

disadvantage of debt factoring

a debt factoring company charges a fee for this service eg 20% of the debt so a business does not gain all of the debt owed to them

what is debt factoring used for

day to day expenditure eg paying bills/suppliers/wages

type of business debt factoring is suitable for

businesses struggling to pay their immediate bills (cash flow crisis) who have lots of debt owed to them. Often medium sized businesses

owner's capital

internal. Savings from owners' are invested into the business to use as finance

advantage of owner's capital

there is no charge involved in using these funds (no interest to pay)

disadvantage of owner's capital

likely to be a restricted amount

what is owner's capital used for

to pay for start up expenses, growth

type of business owner's capital is suitable for

sole trader

retained profit

internal. Business profit is saved over time and then is invested in the business

advantage of retained profit

there is no charge involved in using these funds (no interest to pay)

disadvantage of retained profit

once used, there is less left for emergency funds or to tide a copany over if there is a recession

what is retained profit used for

investment into R+D, expansion, new tecnology (long term)

type of business retained profit is suitable for

all types except new businesses, more likely for large, established businesses who are very profitable

sale of assets

internal. Business sell assets for cash, increasing finance for their own use. They typically sell assets that they are no longer using

advantage of selling assets

there is no charge involved in using these funds (no interest to pay)

disadvantage of selling assets

the business may have to accept a lower valuation of the asset if they need cash urgently

what is sale of assets used for

any purpose eg buying new, upgraded assets, settling debts

type of business sale of assets is suitable for

larger businesses that have valued assets to sell

income statement

a formal financial document that summarises a business's trading activities and expenses to show whether it has made a profit or a loss

high profit quality

source of profits from normal trading ie sales of core goods/services, therefore likely to be repeated next year

low profit quality

source of profits from other activities than sales eg selling of an asset, therefore unlikely to be repeated next year

3 ways of improving profit

increase price, improve quality, increase promotion

2 ways of reducing costs

- reducing cost of sales - source cheaper materials/components/stock, replace workers (involved directly in production/selling) with new machinery to reduce direct wages, relocate production to take advantage of cheaper direct labour
2. reducing expenses - move to cheaper premises (lower rent), source cheaper fuel/energy provider, offer lower salaries, lower marketing costs by finding cheaper alternative stratergies

owners' interest in profit and loss statement

to see how much return they are getting on their investment - drawings

emoloyees' interest in profit and loss statement

if the business has a long term future this will determine job security/wage negotiation (in larger firms)

suppleirs' interest in profit and loss statement

to see if the business is likely to continue being a customer

competitors' interest in profit and loss statement

for corporated businesses, competitors will be able to see financial accounts to get an understanding of trending activities

investors/shareholders' interest in profit and loss statement

indication of profitability of the firm and whether they will receive dividend payments and increase the value of their shares

government's interest in profit and loss statement

to calculate the tax liability of the firm

gross profit margin (GPM)

a type of profitability ratio that calculates gross profit as a proportion of sales revenue

formula for calculating GPM

gross profit / sales revenue x100

net profit margin (NPM)

a type of profitability ratio that calculates net profit as a proportion of sales revenue

formula for calculating NPM

net profit / sales revenue x100

profitability ratios are useful but on what 4 conditions

- they are compared over time to see trend emerging
- they are compared to competitors to see if a business's performance is as good as, if not better, than competitors
- data must be acted upon
- data must be accurate and reliable

managers' interest in profitability ratios

to see if the business is meeting targets to improve profitability, to see areas to focus on improving

stakeholders' interst in profitability ratios

to judge how profitable the business is and whether they should continue to hold shares/buy more

workers/trade union's interest in profitability ratios

to judge whether jobs are secure/whether pay rise could be demanded

operations management

the aspects of the business which are directly linked to the fulfilment of customer orfers. Takes inputs, processes them to form an output and distributes to the customer.

chain of production

the various stages, from raw materials to finished product, that the goods pass through before they are sold to a consumer. Links all three sectors together and relies on their interdependence.

primary sector

involves extraction of raw materials

secondary sector

involves the manufacturing of goods

tertiary sector

involves the selling of finished goods/provision of services

added value

the difference between the cost of inputs and the price consumers are willing to pay for the finished goods

2 reasons why added value may be important

- to pay wages
- can allow a business to charge a premium price and hence increase their profit margin

added value formula

final price - cost of materials