Section 8 - Managing Finance

• Profit


  The money that a business has left from its revenue once costs have been paid
• Cash


  What a business has now to pay its bills
• Profit is not the same as cash
• Cash is constantly flowing in and out of a business
• A business doesn't get the profit it makes straight away - customers may not pay for their goods straight away or the business may not have to pay its costs straight away
• Gross Profit Margin (GPM)


  Gross profit as a percentage of revenue
• Operating Profit Margin (OPM)


  Operating profit as a percentage of revenue
• Profit for the Year Margin


  Profit for the year as a percentage of revenue
• A high profit for the year margin is attractive to shareholders, because it can indicate that they may receive high dividends
• Ways businesses can improve profit margins


  • Increase revenue (e.g. increase prices if demand is price inelastic, reduce prices to increase demand if demand is price elastic, improve product quality)
  • Reduce costs of sales (e.g. find cheaper suppliers)
  • Reduce operating expenses (e.g. find cheaper premises, cut unnecessary administrative tasks)
• A business that's making lots of profit might still run out of cash, and a business that has lots of cash might still end up not making a profit
• However, he needs to pay for his materials in advance and gives customers a one-month credit period
• If he has a particularly expensive month like his van needs repairs costing £1000 he might run out of cash, although his business is still making a profit
• Gross profit margin


  Formula for calculating it
• Cash


  Not the same as profit
• Part of Sai-weet's statement of comprehensive income for 2017 is shown
• The competitor is a much larger firm but has an operating profit margin of 16%
• Sai-weet is considering taking out a loan in 2018, for which the annual interest payments would be £1000
• The loan will pay for new machines to improve the firm's efficiency and the quality of its products
• Some shareholders are opposed to the plan as they are dissatisfied when the profit for the year margin is below 5%
• Calculating appropriate profit margins for Sai-weet and evaluating whether or not it should go ahead with the investment plan


  1. Use data from the statement of comprehensive income

  2. Show working
• Statements of Financial Position are lists of Assets and Liabilities
• Statement of Financial Position


  • Also called balance sheet
  • Shows the financial position of a business at a fixed point in time
  • Includes non-current and current assets, and liabilities
• The net assets figure shows the capital that has been invested in the business
• The total equity figure shows the shareholders' funds
• Non-current assets


  Assets that the business expects to use for more than one year, e.g. machinery, vehicles
• Current assets


  Assets that the business expects to use or convert to cash within one year, e.g. inventory, receivables, cash
• Current liabilities


  Debts that the business needs to pay off within one year, e.g. overdrafts, payables, dividends
• Non-current liabilities


  Debts that the business will pay off over several years, e.g. mortgages, loans
• Bad debts are debts that debtors won't ever pay
• Bad debts are written off as an expense on the statement of comprehensive income
• It's important to be realistic about bad debts - not too optimistic or too cautious
• Current ratio


  • Compares current assets to current liabilities
  • Shows how liquid a firm is and its ability to pay short-term debts
• Acid test ratio


  • Also called liquid capital ratio
  • Measures liquidity by excluding inventory from current assets
• Working capital


  • The finance available for day-to-day spending
  • Calculated as current assets minus current liabilities
• Working capital cycle


  The length of time between buying raw materials and getting cash from sales of the finished product
• The length of the working capital cycle depends on the nature of the product and the credit periods given to suppliers and customers
• Working capital


  The cash and other assets that a business needs to operate on a day-to-day basis
• Working capital cycle


  1. Buying raw materials

  2. Making products

  3. Selling products
• The length of the working capital cycle depends on the nature of the product and the credit period the business gets from suppliers and gives to customers