Finance

• What does the finance department do?

  • Produce cash budgets - helps managers monitor cash flow
  • Produce financial statements - allows managers to monitor performance of the business
  • Control costs- mangers identify where cost have increased and make cut backs
  • Carry out ratio analysis - this provides mangers with information to help them make decisions
• Sources of finance


  • Bank overdraft
  • Trade credit
  • Debt factoring
  • Retained profit
  • Hire purchase
  • Sale and leaseback
  • Commercial mortgage
  • Share issue
  • Debentures
  • Venture capitalists
  • Crowdfunding
• Bank overdraft


  • The business can spend more money than it has in its bank account
  • Easy to arrange with the bank and so ideal for urgent cash requirements
  • The bank usually charges a high interest rate due to the convenience to the business
  • The overdraft can be withdrawn at short notice by the bank and will then need repaid
• Trade credit


  • Allows the business to buy goods from suppliers and pay for them at a later date
  • Prompt payment discounts (which would increase business profits) is lost
  • Supplier can stop giving trade credit if the business pays later than agreed
• Debt factoring


  • A business sells its unpaid invoices to an external factoring company, who then collects the debts and keeps the money
  • Can help the business keep going when cash flow is poor
  • The business will not receive 100% of the Invoice amount from the factoring company (as there is a risk the invoices will not all be collected)- this reduces profits
  • The debt factoring company usually charges high administration fees as it is having to make all the effort
• Retained profit


  • A business holds back profits from previous years
  • It does not need to be repaid or incur interest
  • Useful for making large purchases, such as equipment or motor vehicles
  • If a business uses up its retained profits to help it through periods where cash flow is poor, it will not have enough left to help it grow
• Hire purchase


  • A business can buy an asset by paying an initial deposit and then monthly instalments for a fixed period of time
  • The asset is owned by the business at the end of the repayment period
  • The business does not need to spend a large sum which may be the case if the asset was bought outright
• Sale and leaseback


  • Selling an asset to a finance company and leasing it back from them
  • The money raised from the sale of the asset can boost cash flow
  • The business is no longer responsible for repairs and maintenance
  • Leasing the asset over a long period of time is more expensive than actually purchasing
• Commercial mortgage


  • A large sum of money borrowed from a bank or building society to buy property, repaid over a long period of time with interest
  • The long repayment period helps the business afford to pay for expensive properties
  • The interest rate is often cheaper than a bank loan
  • Mortgages are usually secured against the property, which means that the business could lose the property if it does not keep up with repayments
• Share issue


  • Selling shares in the business to raise funds-known as shareholders
  • PLCs sell shares on the Stock Market, private limited (Ltds) sell shares privately
  • Very large sums of money can be raised, especially for PLCs
  • Dividends have to be paid to shareholders from profits
  • The administration costs of advertising, and selling shares can be expensive
• Debentures


  • Loans borrowed from individuals through the Stock Market
  • Control of the business is retained (unlike selling shares)
  • Does not need repaid until the end of the "loan" period
  • Interest must be paid annually even if the business does not make a profit
• Venture capitalists


  • Individuals who invest in start-up businesses in return for a share of the business
  • Business advice is often provided as well as finance
  • Venture capitalists are willing to take a risk on unproven new businesses
  • Venture capitalists often take a large share of the business, which means control is lost to them
• Crowdfunding


  • Involves taking smaller donations from a number of people via the internet
  • Successfully crowdfunded projects can get huge amounts of attention, on social media and elsewhere, which can help them grow beyond what the money raised alone could have done
  • As part of the crowdfunding process the business can get feedback about their idea and how to improve it
  • Failed projects risk damage to the reputation of the business and people who have pledged money to them
  • Such a public display of an idea risks others copying it
  • Businesses need the time and money to gear up the community, publish their project and bring in investors before any money is raised
• Determining factors for selecting sources of finance

  • Finance costs (Interest rates)
  • Payback term
  • Size and type of organisation
  • Short term finance required
  • Long term finance required
• Cash budgeting


  A cash budget is a forecast of estimated future cash receipts and payments to aid decision making
• Reasons for preparing a cash budget

  • Highlights periods when a negative bank/cash balance is expected
  • Forecasts surplus (extra) cash available
  • Avoid liquidity problems, eg not being able to pay creditors within agreed timescales
  • Helps to secure a loan from the bank, eg if you want to buy new equipment
  • Make comparisons between projected figures (estimates) and actual figures
  • It measures performance of departments
• Ways to solve cash flow problems

  • Use Just in Time inventory control
  • Sell off excess inventory by having a 'sale'
  • Offer cash discounts to encourage customers to pay in cash at the time they buy
  • Charge higher interest on credit sales to encourage customers to pay sooner
  • Switch suppliers to those that will give the business interest-free credit available on purchases
  • Pay for non-current assets in instalments, using hire purchase or leasing, to avoid large one-off cash payments
  • Look for ways to reduce expenses, eg more e-commerce to reduce rental of premises
  • Reduce all drawings or dividends back to a suitable level until cash flow improves
  • Change elements of the marketing mix (eg lower price or increase advertising) to encourage sales
  • Sell debts to a debt factoring company which will pay cash upfront to the business
• Impact of poor cash flow

  • Unable to pay suppliers which may mean that raw material will not be supplied
  • Need to find a cheaper supplier, which could result in a reduction in the quality of raw materials
  • Increased interest and bank charges to pay if borrowing from the bank
  • Employees become demotivated and may leave to work elsewhere
  • Unable to invest in the business, so unable to grow and remain competitive
  • Need to offer discounts to encourage customers on credit to pay early, which will reduce profits
  • Run out of money and have to shut down if cash flow problems cannot be solved
• Public limited companies are required by law to prepare and publish FINANCIAL STATEMENTS - these consist of two documents: 1. An INCOME STATEMENT and 2. A STATEMENT OF FINANCIAL POSITION
• Income Statement


  Shows the amount of money made from selling goods or services (Sales revenue), the amount of money spent on selling goods (Cost of sales), the profit made from buying and selling (Gross Profit), the running costs incurred during the year (Expenses), and the profit made after expenses are deducted from gross profit (Profit for the Year)
• Statement of Financial Position

  • Shows the items a business owns (assets) and the items they owe (liabilities), and states the overall value of the business
  • Can be used by investors and potential investors to determine the possible return on their investment
  • Can be used by suppliers to determine the risk of lending to the organisation/likelihood of repayment
  • Can be used to calculate ratios which can then be used to inform decision making
• Types of training


  • Apprenticeship
  • Training schemes
  • Virtual learning
  • Continuous
  • Staff
• Ratio analysis


  A technique used to analyse a business's financial performance
• Purposes of ratio analysis (advantages)

  • Compare current year's performance with previous years
  • Compare performance with competitors
  • Compare performance with industry averages
  • Highlight problem areas to improve
  • Highlight trends to aid future decision making
• Ratio analysis has limitations (disadvantages)
• Limitation: Historical information


  Financial statements contain historical information, less relevant to current/future position
• Limitation: External factors


  Ratios do not take account of external factors like PESTEC
• Limitation: Competitor comparison


  Difficult to find competitors of exact type and size, comparisons may not be relevant
• Limitation: Internal factors


  Ratios do not take into account internal factors like workforce skills, management experience
• Limitation: New product development


  Ratios do not account for development costs or short-term improvements from new products
• Types of ratios


  • Profitability ratios
  • Liquidity ratios
  • Efficiency ratios
• Efficiency ratios


  Measure how well a business uses its resources
• Gross profit percentage


  Formula: gross profit / revenue x 100

  Measures the percentage of profit made from buying and selling, higher is better
• Profit for the year percentage

  Formula: profit for the year / revenue x 100

  Measures the percentage of profit made once expenses are deducted from gross profit, higher is better
• How to improve gross profit percentage

  Increase unit selling price

  Decrease cost of sales (switch to cheaper supplier, negotiate trade discounts)

  Decrease business expenses (find premises with lower rent)