Theme 2 (Finance)

• Sections covered in this theme


  • Raising finance
  • Financial planning
  • Managing finance
• Owners capital - personal savings


  Benefit: Immediate availability

  Drawback: Limited in amount
• Retained profit


  Benefit: Cheap (no interest)

  Drawback: No inflationary benefits - inflation can reduce the value of debt
• Sale of assets


  Benefit: No need to involve third parties

  Drawback: Opportunity cost as assets might still be useful
• Family & friends


  Benefit: Might not want a stake, meaning control is not relinquished

  Drawback: Might lead to breakdowns in relationships if money not repaid
• Banks


  Benefit: Wide range of options

  Drawback: Money must be repaid or assets repossessed
• Peer-to-peer funding


  Benefit: Favourable interest rates

  Drawback: Not covered by Financial Services Compensation Scheme
• Business angels


  Benefit: Bring expertise to help with decision-making

  Drawback: Control relinquished/potential conflict
• Crowdfunding


  Benefit: Good publicity for the business

  Drawback: No control on who is buying a stake in the business
• Other businesses


  Benefit: Can obtain finance that may not be available elsewhere

  Drawback: May need to relinquish some control
• Loans


  Benefit: Flexible - can be short-term or long-term

  Drawback: Interest payments must be paid; might be high depending on business
• Share capital


  Benefit: No repayment required

  Drawback: Pressure from equity partner might focus on short-term returns
• Venture capital


  Benefit: Can include expertise to help with decision making

  Drawback: Loss of control
• Overdrafts


  Benefit: Flexible, only use as and when you need it

  Drawback: Expensive as interest rates are high
• Leasing


  Benefit: Flexible, over fixed period allowing you to replace equipment

  Drawback: More expensive over duration of lease period
• Trade credit


  Benefit: Access to goods without immediate payment

  Drawback: Potential negative effect on cash flow
• Grant


  Benefit: Does not need to be repaid

  Drawback: Can be difficult and time-consuming to access
• Businesses with unlimited liability might find it easier to raise finance because lenders will be reimbursed if the business defaults; they are often seen as more credible as owners have more to lose and may therefore take less risks
• Businesses with limited liability might find it easier to raise larger amounts of capital because shareholders' private assets are protected, and they know the extent of their liability; however smaller business owners with limited liability are required to give personal guarantees of the company's debts
• Limited liability


  Legal status that means shareholders can only lose the original amount they invested in a business
• Unlimited liability


  Legal status which means that business owners are liable for all business debts
• Business plan


  A written document that describes in detail how a business, usually a new one, is going to achieve its goals
• Cash-flow forecast


  A forecast of the cash inflows and cash outflows of a business over time
• By outlining a structured model of how a business is going to be run to achieve objective, lenders are more likely to borrow money to the business as the risk is likely to be lower
• Uses of cash-flow forecast


  • Allows businesses to see where there may be cash-flow issues in the future

  Can ensure suppliers and employees can be paid on time to avoid disruptions

  Can provide reassurance to owners and investors
• Limitations of cash-flow forecast


  • Based on estimates and assumptions which can be inaccurate

  Doesn't factor in unforeseen events

  Must be completed by trained individuals which is not always possible
• Purpose of sales forecasts


  Mainly to be able to set budgets that can be allocated in order to finance the business areas in order to achieve the forecast sales

  Helps to manage key aspects such as inventory levels and cash-flow

  Helps to prepare for growth
• Difficulties of sales forecasting


  • Based on estimates, even when based on historical data

  Difficult to predict as external factors are influential - e.g. consumer trends, changes in economic climate, competitor actions etc
• Factors affecting sales forecasts


  • Consumer trends

  Economic variables

  Competitor actions
• Examples of fixed costs


  • Rent

  Salaries

  Insurance and banking fees
• Examples of variable costs


  • Raw materials

  Hourly wages

  Bought-in stocks
• Sales volume


  Number of units sold over a given time period
• Sales revenue


  Volume sold x average selling price
• Contribution per unit


  Selling price per unit - variable cost per unit
• Break-even point


  Fixed costs / Contribution per unit
• Margin of safety


  Actual output - break-even point
• Two limitations of break-even analysis:

  1. Assumes selling price remains constant

  2. Variable costs such as raw materials are likely to change as output increases, such as benefits of bulk buying as volume increases
• Two types of budget

  • Historical

  Zero-based
• Purpose of budgeting


  • Allows performance to be measured by monitoring spending against a specific target

  Provides guidance for managers/supervisors on how much to spend and determines how they should spend it

  Should improve efficiency and avoid waste
• Difficulties of budgeting


  • Accuracy - they are only as good as the data used to create them

  Can be time-consuming to prepare