Business Management - Finance and Accounts

Introduction to Finance

• Businesses need money for various activities.
• Businesses spend money on capital and revenue expenditure.
• Factors to consider when selecting sources of finance: availability, cost, and repayment period.

Capital Expenditure

• Finance spent on fixed assets for long-term revenue generation.
• Examples: Capital equipment, Furniture, fixtures and fittings, Computers & IT systems, Intellectual property ,Machinery, Mergers & acquisitions, Property & premises, Vehicles

Revenue Expenditure

• Finance spent on daily running of the business.
• Examples: Advertising & promotion, Energy costs, Freight & delivery, Insurance, Office supplies & administration, Raw materials & components, Rent, Wages & salaries

Internal Sources of Finance

• Personal funds (for sole traders): Main source for sole traders and partnerships; limited by savings.
• Retained profit: Finance kept by the business after taxes and dividends; zero cost but unavailable if there are losses.
• Sale of assets: Selling unused assets to raise finance; zero cost, but funds depend on asset desirability.

External Sources of Finance

• Share capital: Main source for limited companies; can raise large amounts, but time-consuming and no guarantee of investor interest.
• Loan capital: Obtained from banks; interest charged, repayment in installments.
• Overdrafts: Temporary funds from bank accounts; flexible but high interest rates.
• Trade credit: 'Buy now and pay later'; allows time to process materials, but late payments incur penalties.
• Crowdfunding: Raising finance from individuals for new ventures; potentially high reward, but low success rate.
• Leasing: Renting assets over a contracted period; useful without capital to purchase assets.
• Microfinance providers: Financial services for entrepreneurs from disadvantaged sectors.
• Business angels: Wealthy individuals investing in high-growth businesses.

Appropriateness of Sources

• Financial managers must be aware of repayment periods.
• Short-term: Within 12 months.
• Long-term: More than five years.
• Expenditure type and availability of internal finance influence the choice of finance source.

Costs and Revenues

• Businesses spend money to earn money (costs).
• Set-up costs: Needed to start a business.
• Running costs: Ongoing costs of running the business.

Types of Costs

• Fixed costs: Constant regardless of output (e.g., rent, salaries).
• Variable costs: Change with output (e.g., raw materials, commission).
• Direct costs: Related to a specific project or product.
• Indirect/overhead costs: Cannot be traced to a single product.

Revenue

• Sales Revenue $= Price × Quantity sold$
• Revenue Streams: advertising, transaction fees, franchise costs, sponsorships, subscriptions, merchandise, dividends, donations, interest earnings

STEEPLE Analysis for Bakeries

• External factors impacting bakeries: social, technological, economic, environmental, political, legal, and ethical.
• Strategies: reduce costs and/or increase revenue.

Final Accounts

• Comprise the Statement of Profit and Loss and the Statement of Financial Position (balance sheet).
• Stakeholders: shareholders, employees, managers, competitors, government, financiers, suppliers, potential investors

Statement of Profit or Loss (Profit-Making)

• Shows net profit or loss over a trading period.
• Gross Profit $= Sales revenue – Cost of sales$
• Profit Before Interest and Tax $= Gross profit – Total expenses$
• Profit Before Tax = Profit BI&T – Profit BT
• Profit for Period $= Profit BT – Tax$
• Retained Profit $= Profit for period – Dividends$

Statement of Profit or Loss (Non-Profit)

• Replaces "profit" with "surplus."
• Gross Surplus $= Sales revenue – COS$
• Surplus Before Interest $= Gross surplus – Total expenses$
• Surplus Before Tax $= Surplus BI – Surplus BT$
• Surplus for Period $= Surplus BT – Tax$
• Retained Surplus $= Surplus for period$

Improving Profit/Surplus

• Increase sales revenue
• Reduce cost of sales/expenses.

Statement of Financial Position (Balance Sheet)

• Snapshot of a firm's value at a point in time.
• Assets: Monetary value items owned by the business.
• Liabilities: Legal obligations to repay lenders or suppliers.
• Equity: Value of the business belonging to the owners.

Assets

• Non-current assets: Used for business operations for more than 12 months.
• Current assets: Likely to be converted into cash within 12 months.

Liabilities

• Current liabilities: Debts settled within one year.
• Non-current liabilities: Debts repaid after 12 months.

Equity

• Profit-Making: Share capital and retained earnings.
• Non-Profit: Retained earnings.

Intangible Assets

• Non-physical fixed assets that earn revenue (e.g., brands, patents, copyrights, goodwill, registered trademarks).

Depreciation

• Straight-Line Depreciation: Simple calculation, but unrealistic.
  • $Annual depreciation = (Purchase cost – Residual value) / Lifespan$
• Units of Production Depreciation: Better insights into true running costs.
  • $Depreciation expense = Depreciation per unit* x Number of units produced$
  • $*Depreciation per unit = (Purchase cost – Residual value) / Expected number of units over lifetime$

Ratio Analysis

• Quantitative management tool for analyzing financial performance.
• Historical and inter-firm comparisons.

Profitability Ratios

• Gross Profit Margin (GPM): Profitability after deducting direct costs.
• Profit Margin (PM): Profitability after deducting all costs.
• Return on Capital Employed (ROCE): Financial performance compared to capital invested.

Profitability Ratio Formulas

• GPM = (Gross Profit / Sales Revenue) x 100
• PM = (Profit Before Interest and Tax / Sales Revenue) x 100
• ROCE = (Profit Before Interest and Tax / Capital Employed) x 100

Strategies to Improve Profitability

• Increase revenue/decrease costs.
• Control expenses.

Liquidity Ratios

• Assess a firm's ability to pay its short-term liabilities.
• Current Ratio = Current Assets / Current Liabilities
• Acid Test Ratio = (Current Assets – Stock) / Current Liabilities

Efficiency Ratios (HL Only)

• Stock Turnover = Cost of Sales / Average Stock
• Debtor Days = (Debtors / Total Sales Revenue) x 365
• Creditor Days = (Creditors / Cost of Sales) x 365
• Gearing Ratio = (Non-Current Liabilities / Capital Employed) x 100

Improve Efficiency Ratios (HL Only)

• Reduce stock levels, threatening legal action to recover monies owed from debtors, pay creditors sooner.

Insolvency vs. Bankruptcy (HL Only)

• Insolvency: Unable to settle debts when due.
• Bankruptcy: Formal declaration of inability to settle debts.

Cash Flow

• Cash or liquid assets available for the daily running of a business.

Profit vs. Cash Flow

• Profit appears on the income statement.
• Cash flow appears on the cash flow statement.

Working Capital Cycle

• Time difference between paying for production costs and receiving cash from sales.

Liquidity Crisis

• Insufficient cash in the working capital cycle.
• Cash Flow Forecast: financial document that shows the expected movement of cash in and out of a business over a period of time.

Investment Appraisal

• Quantitative and qualitative approaches to evaluate investment decisions.

Quantitative Methods:

• Payback Period
• Average Rate of Return
• Net Present Value (HL only).

Payback Period Formula

• Payback Period $= Capital cost / Contribution per month$
• $ARR= (Total returns – Capital cost) / Years of use x 100 / Capital cost$

Net Present Value (HL Only)

• NPV = Sum of present values – Original cost

Qualitative Investment Appraisal

• PORSCHE© factors: Predictions, Objectives, Risk profiles, State of the economy, Corporate image, Human relations, Exogenous shocks.

Budgets (HL Only)

• Financial plan of expected revenue and expenditure.

Cost vs. Profit Centers (HL Only)

• Cost Center: Departments that incur costs but do not generate profit.
• Profit Center: Departments that incur costs and generate revenues.

Variance Analysis (HL Only)

• Looking at the difference between the budgeted figure and the actual expenditure figure.

Budgeting (HL Only)

• Planning and guidance, coordination, motivation and control