Unit 5 - finance:

• An important distinction needs to be made between profit and cash flow. They are similar concepts – but not quite the same!
• Profit

  The difference between total revenues and total costs over a period
• Cash flow

  The difference between total cash inflows and total cash outflows over a period
• Differences between cash flow and profit

  • Timing differences (sales to customers made on credit, payments to suppliers)
  • The way fixed assets are accounted for (payment for fixed asset = cash outflow, cost of fixed asset = treated as an asset not a cost, depreciation is charged as cost when the value of fixed assets is reduced)
  • Cash flows arising from the way the business is financed (inflows from shareholders, bank loans, factoring etc., repayments of amounts loaned, payment of dividends)
• The relevant financial statement is the Income Statement – a historical record of the trading performance of a business over time
• Revenue

  Revenues (sales) during the period
• Cost of sales

  Direct costs of generating revenues. Includes the cost of raw materials, components, goods bought for resale and the direct labour costs of production
• Gross profit

  The difference between revenue and cost of sales. A simple but very useful measure of how much profit is generated from every £1 of revenue before overheads and other expenses are taken into account. Is used to calculate the gross profit margin (%)
• Administrative expenses

  Operating costs and expenses that are not directly related to producing the goods or services
• Cost of sales

  Direct costs of generating revenues, including cost of raw materials, components, goods bought for resale and direct labour costs of production
• Gross profit

  The difference between revenue and cost of sales, a measure of how much profit is generated from every £1 of revenue before overheads and other expenses are taken into account
• Operating profit

  A key measure of profit, recording how much profit has been made in total from the trading activities of the business before accounting for how the business is financed
• Finance expenses

  Interest paid on bank and other borrowings, less interest income received on cash balances
• Taxation

  An estimate of the amount of corporation tax payable on the profits for the period
• Profit for the year

  The amount of profit left after tax has been accounted for, which shareholders then decide how to allocate between dividends and retained profits
• Revenue Objectives

  • Revenue growth (percentage or value)
  • Sales maximisation
  • Market share
• Cost Minimisation

  • Achieving the most cost-effective way of delivering goods and services to the required level of quality, leading to lower unit costs, higher gross profit margin, higher operating profits, improved cash flow, and higher return on investment
• The final area to look at in terms of financial objectives relates to the way that a business is financed, in particular the long-term finance which forms the foundations for the business
• Investment

  Intended to help generate a return (profit) over more than one year
• Two common investment objectives

  • Level of Capital Expenditure
  • Return on Investment
• Level of Capital Expenditure

  Set at either an absolute amount (e.g. invest £5m per year) or as a percentage of revenues (e.g. 5% of revenues)
• Return on Investment

  Usually set as a target % return, calculated by dividing operating profit by the amount of capital invested

  
• Equity

  Represents amounts invested by the owners of the business, comprising share capital and retained profits
• Debt

  Represents long-term finance provided to the business by external parties, comprising long-term bank loans and other long-term debt (e.g. debentures)
• Business A has a much lower debt/equity ratio (25%) compared with Business B
• Reasons why high levels of debt can be an objective

  • Where interest rates are very low = debt is cheap to finance
  • Where profits and cash flows are strong; so debt can be repaid easily
• Internal influences on financial objectives

  • Business ownership
  • Size and status of the business
  • Other functional objectives
• External influences on financial objectives

  • Economic conditions
  • Competitors
  • Social and political change
• Capital structure

  The long-term financial base of a business split between equity sources and long-term debt
• Cost minimisation

  Strategy that aims to achieve the most cost-effective way of delivering goods and services to the required level of quality
• What are revenues?
• What are costs and how do they relate to output?
• Why profit is important in business
• Revenues

  The amount (value) of a product that customers actually buy from a business
• The relationship between quantity demanded and price can be shown graphically by drawing a demand curve
• Different names for the value of what a business sells

  • Sales
  • Revenues
  • Income
  • Turnover
  • Takings
• Total revenue

  Volume sold x average selling price
• Revenue calculation example

  • Blue: 5,000 units at £10 = £50,000
  • Red: 2,500 units at £12 = £30,000
  • Pink: 8,000 units at £11 = £88,000
  • Purple: 4,000 units at £10 = £40,000
  • Total: 19,500 units = £208,000
• Revenues rise as higher quantities are sold
• Ways to increase revenues

  • Increase quantity (amount) sold
  • Achieve a higher selling price