Studied by 3 peoplebudget
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
Note
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