3.5 finance

• Gross profit?

  sales revenue - costs of production
• operating profit?


  sales revenue - expenses
• return on investment? ROI


  profit from investment/capital invested x 100
• Contribution

  Sales revenue - variable costs

  OR

  sales prices per unit - variable costs
• Main types of financial objectives

  • Revenue
  • Cost
  • Profit
  • Cash Flow
  • Objectives for investment levels
  • Capital structure
  • Objectives related to debts as a proportion of long-term funding
• Financial objectives

  • Focus for decision making
  • Improves co-ordination (overall teamwork) as all departments have a common purpose
  • Act as a yardstick which success or failure can be measured against
  • Improves efficiency by examining the reasons for success or failure in different areas
  • Allows shareholders, especially investors to assess whether the business is going to provide a worthwhile investment
  • Allows outside organisations such as suppliers and customers to confirm the financial viability of a business
• Disadvantages of setting financial objectives

  • Can be difficult to set realistic objectives
  • External changes can occur and stop a business achieving its financial objectives
  • Some objectives can be difficult to accurately measure
  • Reasons for success/failure can be impossible to determine
  • The finance department tends to be responsible for financial objects whereas the actual performance will depend on the performance of all departments
  • Financial objectives can clash with other financial/non-financial objectives
• Return on investment


  A measure of the efficiency of a financial investment, which is used to compare the financial returns of alternative investments
• Calculating return on investment as a profit

  Financial gains from investment - Cost of investment
• Calculating return on investment as a percentage

  Return on investment / Cost of investment x 100
• Debts


  Money owed by one individual/organisation to another individual/organisation e.g. bank loans
• Long-term funding

  Money provided to a business which does not require repayment within a year e.g. share capital
• Calculating debts as a proportion of long-term funding

  Debts / Long term funding x 100
• It is important to note the differences between cash flow and profit- long term vs short term finance. A business must be profitable to survive in the long-term.
• Revenue


  The income received from an organisation's activities
• Cost of sales


  Cost of making or buying goods that have been sold/variable costs
• Profit from other activities

  Income that isn't from the normal trading activities e.g. rent or, income from an extraordinary item which is a one-off gain e.g. the sale of a property
• Tax

  Corporation tax on profits made by the organisation
• Profit for the year

  Operating profit + profit from other activities - finance costs - tax
• Break even

  • Revenue = total costs
  • Profit = zero
• Break-even point (BEP)


  The level of sales where a business breaks even where revenue covers all costs
• Calculating the break-even point is a part of a business' planning
• Calculating break-even point (BEP)

  Fixed costs / Contribution per unit
• Margin of Safety

  Planned output - break-even point (BEP)
• Cash Flow Forecasting


  • Help to identify potential cash flow problems in advance
  • Guides the firm towards appropriate action
  • Ensures efficient cash flow is available to make payments
  • Provide evidence towards the request for financial assistance
• Hard to predict changes in the economy, changes in consumer tastes and trends, inaccuracies in market research could lead to inaccurate forecasting, uncertainty and risk
• Liquidity


  Ability to convert an asset into cash without a loss or delay
• The most liquid asset to possess is cash
• Budget


  A financial plan of spending and anticipated revenues
• Purposes of budgets

  • Gain financial support
  • Establish priorities
  • Improve efficiency
  • Encourage delegation and to motivate staff
  • Control costs
  • Assign responsibility
• Income budget


  The agreed, planned income of a business over a period of time
• Expenditure budget


  The agreed, planned expenditure of a business over a period of time
• Profit budget


  The agreed, planned profit of a business over a period of time
• Advantages of budgeting

  • Help to identify potential budgeting issues
  • Provides targets to be achieved- motivating
  • Helps to gain financial support from investors
• Failure to reach unreasonable targets can be demotivating, if inflexible, unforeseen opportunities can be missed, can be difficult to plan realistic figures
• Variance analysis


  Comparing budgeted figures to actual figures
• Variance


  The difference between budgeted figures and actual figures
• Favourable variance


  Profit is higher than budgeted
• Adverse variance

  Profit is lower than budgeted
• Sources of Finance


  • Long Term
  • Short Term
  • Crowd funding
  • Bank loan
  • Venture capital
  • Grants
  • Hire purchase
  • Retained profit
  • Owners savings
  • Share issue
  • Trade credit
  • Overdraft
  • Debt factoring
  • Leasing