SL Business- Finance

Sources of Finance:

Internal sources:

1. Personal funds (for sole trader) = own savings

2. Retained profit = profit left after all deductions have taken place (including dividends) later re-invested in the business à profit not distributed to owner + shareholders do not receive extra profit from investment

3. Sale of assets = selling assets (eg: machinery) that are no longer required

4. Sale and leaseback arrangement = business sells an asset to get cash à then rents it

5. Opportunity cost = potential cost of missing an opportunity by choosing one option over the other one

External sources:

1. share capital = money raised by business selling shares through (long term)

2. flotation = company become publicly held and sells share to public through stocks à initial sale = Initial Public Offering (quotazione in borsa)

3. rights issue = existing shareholders given opportunity to buy additional shares at discounted price

4. bank loan = usually for larger businesses à long term repayment

5. business mortgage = loan used to purchase buildings

6. overdrafts = money arrangement between business and bank à bank can spend more money than it has in its bank account à short term + high cost loan with higher rate of interest

7. trade credit = agreement with suppliers to pay for resources at a later date (agreed timeframe) à short term + usually no interest

8. crowdfunding = use of small sums of capital from large number of individuals to finance a project à competition à need good business plan

9. leasing = assets (eg: machinery) made available to business in return for regular payments (form of rental) à not useful for long term

10. microfinance providers = small lenders who make finance directly available to business or individuals who would be unable to access finance from anywhere else à amount available very limited

11. business angels = individuals investing in start ups or expanding businesses

12. venture capitalist = organisations specifically set up to lend money or buy shares in startup business à privately held company + long term

13. debentures = loans to company to raise finance with a fixed rate of interest à long term

Costs and revenues

Types of costs:

1. fixed = costs that stay constant irrespective of units produced

eg: rent + salaries

1. variable = costs that vary depending on number of units produced

eg: raw materials + delivery costs + taxes + marketing + manufacturing wages

1. direct = costs directly attributed to a specific product

eg: materials + production equipment

1. indirect = costs not specific to a single product line

eg: electricity + rent

revenue = value of units sold by business over period of time à usually increases as sales volume (quantity sold) increases

sales revenue = quantity of units sold x selling price

revenue streams = sources that generate revenue other than sales

1. dividends (money paid by company to their shareholders from its profits) = business sometimes purchase share in other company

2. donations + sponsorship

3. advertising revenue

4. interest = business holds big amount of cash as bank deposit à earn interest

Final accounts = details financial performance of a business

statement of profit and loss = shows income + expenditure of business over period of time à calculates amount of profit

Statement of financial position/balance sheet = shows financial structure of a business

Net assets = assets – liabilities

Equity = amounts owed to shareholders

1. retained earnings = include also retained profit (P or L)

equity and total liabilities need to be the same

How stakeholders use accounts

1. shareholders = identify asset structure + value of business à whether investment is growing + calculate working capital

2. managers + directors = identify financial position + assess working capital[1] à enough liquid[2] current assets to pay bills + can determine whether to raise funds by borrowing or other means

3. suppliers + creditors = used to judge whether or not to trade credit with company

4. employees = to see how much pay/tax etc.

Intangible assets = non physical assets à cannot physically be held but still hold value for business

1. intellectual property = anything creative

2. brand value = name + logo

3. customer relationship

4. software + technology

5. contracts and agreements

6. goodwill = company’s reputation

7. licences + permits

Profitability and liquidity ratio analysis = extract info from financial accounts to see business performance + good for decision making à good data

Profitability ratios:

Gross profit margin = shows proportion of revenue that is turned into gross profit à how good business is at selling + making products

1. higher percentage = for luxurious brands

2. lower = brands with little differentiation and compete on price

Profit margin = shows proportion of revenue that is turned into profit before tax + interest

Return on capital employed = compares profit made by business to amount of capital invested

1. higher percentage = better à money used to finance company

Capital employed = non current liabilities + equity

How to improve these ratios

Gross profit margin =

1. increase sales revenue =

2. increase value of sales = raise prices + sell premium products

3. increase volume of sales = price tactics + increase marketing activities

4. reduce direct costs = reduce variable costs

Profit margin =

1. increase gross profit margin = see above

2. reduce overhead costs = reducing staffing levels + cheaper premises à has a cost on company

Return on capital employed (ROCE) =

1. increase level of profit without introducing new capital

2. maintain level of profit while reducing amount of capital

Liquidity ratios = liquidity à turn assets in cash quick à ways to calculate:

1. current ratio = quick way à indicates how many £ of current assets is available to cover each £1 of short term debt

1. the acid test ratio = precise way à least liquid form of assets (stock) provided to calculate acid test to measure business ability to meet short term debts quickly

Low ratio = struggle

How to improve these ratios

1. reduce credit period offered to customers = collect money owed from customers quickly à increase level of current assets

• customers may move to competitive business

1. ask suppliers for extended repayment period = will not reduce current liabilities + some unwilling

2. use overdrafts or short term loans

3. sell off excess stock

4. sell assets or sale and leaseback arrangement

5. introduce new capital + reduce drawings out of business = more assets in business à take out less for personal use

Cash flows = movement of money in and out of business

Working capital = money a business has available to fund day to day activities à sometimes net current assets in statement of financial position

Formula = Current assets – Current liabilities

Managing working capital = lack of working capital = business likely to fail if cannot meet its immediate financial obligations à cash most liquid form of asset = used to pay off debts quickly

• debtors and stock = less liquid

• business struggling = convert current assets into cash as quickly as possible

• request extension of payment terms

• short term loans or overdrafts = can access cash easier

if business too much working capital

• holding large amounts of cash = missing opportunity for investment

• holding large amounts of stock = extra storage costs

Liquidity position = information from balance sheet

• liquidity = ability of business to meet short term commitments w available assets

• business that cannot pay bills = fail very quickly even if profitable

• manage liquidity = key way to manage risk

cash flow forecasts = prediction of anticipated cash inflows and outflows

Capital injection = owner putting money into business

Net cashflow = total cash inflows – total cash outflows

B – C = D

Opening Balance = amount of cash a business has at start of month

Closing Balance = opening balance + net cashflow à opening balance of next month

A + D = E

Relationship between investment, profit and cash flow

Strategies for dealing with cashflows problems

1. reduce credit period offered to customers = increase level of current assets à customers may change business

2. ask suppliers for extended repayment period

3. make use of overdrafts + short term loans

4. sell off excess stock

5. sell assets + leaseback arrangements

6. introduce new capital + reduce drawings from business

Investment appraisal = comparing expected future cash flows of an investment with initial expenditure

• before investment = data needs to be collected à requires time + skill

2 methods to appraise (evaluate + judge) value of investment

1. Simple payback period = calculation of amount of time it is expected for investment to pay back for itself

2. Find last year cumulative cash flow is negative à if year 3 = payback will be 4 years + ? months

3. To calculate months =

1. Get decimal number = always round up to get months

2. Good = simple + can identify point when investment paid back

3. Bad = ignores long term profitability of investment + assumes future cash flow have same values + influence decision making

1. Average Rate of Return (ARR) = average annual profits of investment expressed as percentage of initial amount of money invested in project

1. Capital cost = cash flow of year 0

2. Good = considers all net cash flows

3. Bad = ignores timing of cash flows + opportunity cost of investment ignored

4. If ARR lower than rate of interest = not a good investment à if little difference = uncertainty  

Example:

	Net cash flow	Cumulative cash flow
Year 0	(10 000 000)	(10 000 000)
Year 1	3 000 000	(7 000 000)
Year 2	5 500 000	(1 500 000)
Year 3	6 700 000	5 200 000
Year 4	10 000 000	15 200 000
Year 5	60 000 000	75 200 000

Simple payback method:

1. Last year cumulative cash flow negative = (1 500 000) à year 3 + ? months

2. (1 500 000/6 700 000) x 12 = 2.6 à 3 months

3. 3 years + 3 months

Average Rate of Return:

1. Total returns = 3 000 000 + 5 500 000 + 6 700 000 + 10 000 000 + 60 000 000 = 85 200 000

2. Capital cost = (10 000 000) à 10 000 000

3. Years of use = 5

[1] Working capital = money used day to day by business

[2] Liquid assets = assets than can be converted to cash quickly