Finance

Why do businesses need Finance

Short term finance needs- to pay day to day costs such as employee wages and customer bills. Overdraft and trade credit may be used

Long term finance needs- needed to fund the purchase of non current assets. Loans and mortgages are used.

Start-up finance- are needed by the business to pay for fixed assets and current assets

Business expansion- finance is used to help the business grow by investing into developing new products (research development).

Internal sources of finance

  • Personal savings - when a business is funded by using an individual’s personal savings

  • Retained profit- is the surplus of revenue over costs generated over the past few years and not distributed to owners

  • Selling assets- selling non current assets like land and machinery that are no longer required. cons- may show the business is in trouble

Pros- no interest rates, quicker as no paperwork,

Cons- finance may not be sufficient , owner dissatisfaction

External sources of finance

  • Overdraft- is when business can spend more money than they have in their account. pros-flexible, interest is only paid on account overdrawn cons-high interest chargers and not suitable long term

  • Trade credit- is when a business has an agreement to delay paying customers. pros- no interest to be paid, sell goods before paying for stock. cons-not all stock can be bought using trade credit

  • Loans- money borrowed from the bank or other financial provider with a fixed interest rate. pros- getting a loan is straightforward and banks will not ask for percentage of the business. cons- not flexible, interest will be charged

  • Selling shares- private limited company can sell a percentage of the business to family and friends in exchange for money. pros- no repayment , reduced risk and more credible as trusted by investors. cons- profit is shared, conflict and loss of control.

  • Venture capital- is when a private investor invests money into the business. pros- no repayment, powerful network and expert knowledge. cons- loss of control,dilution distraction.

  • Crowd funding- is used raise money from small investors online. pros-free marketing and does require repayment. cons- funding is not guaranteed and time consuming

Factors affecting choice of finance

  • Timescale- short or long term source of finance

  • Legal structure- sole traders, partnerships and private limited companies have more lending risk compared to public limited companies

  • Cost- interest rates add to the costs eg loans and selling share in public limited company.

  • Control-selling shares or venture capital can lead to loss of control for business owners

  • Purpose of finance- some options are only suitable for certain uses like mortgage for property and overdraft for daily bills

  • Level of existing debt- depending the amount of money in debt

Cash inflow- money coming into the business eg.sales revenue,sale of assets and interests received

Cash outflow- money leaving the business eg. wages, loan repayments

Net cash flow

Purpose of cash

  • Cover operating costs

  • Unexpected expenses

  • Pay for supplies

Cash Flow forecast- is a prediction of the anticipated cash inflows and cash outflows for 12 to 6 month period.

Closing balance formula- Opening balance- Cash outflow+cash inflow

Strategies to improve cash flow

  • Reduce credit period offered to customers

  • Ask suppliers for extended repayment period

  • Sell of excess stock

  • Sell fixed assets

Revenue- is the value of the goods sold by a business over a period of time.

Fixed Costs- are the costs of a business that do not change with output. eg- employee salaries

Variable Costs- costs that vary with output. eg raw materials

Total costs- sum of fixed and variable costs

Profit- is total revenue- total costs

Profit can be increased by

  • Reducing costs

  • Increasing revenue

Loss- is when the costs are greater than revenue

Break even point- is the number of units a business must sell to reach the point where revenue is equal to total costs. Neither profit or loss is made

Factors that impact break even

  • Revenue increase

  • Revenue decrease

  • Cost increase

  • Cost decrease

Limitation of Break even graph

  • Assumes business sells everything it produces

  • All products are sold at the same price

  • It is unrealistic

Tip- Always round up if given in decimals

Contribution- Selling price - variable cost per unit

Break even point in money = break even point in units*selling price

Margin of safety- is amount sales can fall before a business reaches its break even point

A statement of comprehensive income records the income and costs of a business incurred over a period of time (usually one year) (Income statement)

Gross profit= Revenue- Costs of sales

Net profit = Gross profit - expenses

Operating profit is the same as Net profit

Operating profit = gross profit - expenses

Statement of financial position- also known as a balance sheet is the financial statement which shows the assets, liabilities and capital of a business on a particular date.

Assets- are items that are owned by the business

Current assets - include cash and other items that can turned to cash quickly eg inventory and trade receivables

Non Current assets - items owned by the business in the long term eg vehicles, machinery and land.

Net Current Assets = Current Assets - Current Liabilities

Liabilities- are items that are owed by a business.

Current liabilities- short term financial obligations that must be paid within one year eg trade payables and overdrafts

Non Current liabilities- money owed by a business that are due to be rapid in over 12 months. eg- loans and mortgages

How to increase gross profit

  • Reduce costs

  • Increase revenue

How to increase operating profit

  • Reduce expenses

  • Increase profit margin

Mark-up- profit made on each item sold

RoCE- measures how effectively a business uses the capital invested to generate a profit

How to increase RoCE

  • Increase level of profit without introducing new capital

  • Maintain the level of profit