2.3 Managing Finance

• Gross profit


  The difference between sales revenue and the costs directly related to production
• Operating profit


  Gross profit minus the indirect expenses involved in operating the business
• Higher and increasing profit margins are preferable, as it means that more revenue is being converted to profit
• Statement of comprehensive income

  An end of year financial statement that shows all of a business's income and expenses over the previous twelve months
• Leasing rather than buying machinery weakens the balance sheet as a business owns fewer non-current assets
• Gross profit margin


  The proportion of revenue that is turned into gross profit and is expressed as a percentage
• Net profit margin


  The proportion of revenue that is turned into net profit before tax and is expressed as a percentage
• Variable costs can be reduced by buying cheaper stock
• Liquidity


  The ability of a business to meet its short term commitments with its available assets, e.g. payments to creditors
• Acid test ratio


  A more precise way to measure liquidity than the current ratio, as it excludes inventory and stock from current assets
• Working capital


  The money that a business has to fund its day-to-day activities
• A business can have too much working capital and may miss out on the benefits of using it to purchase better fixed assets or make other investments
• Statement of financial position


  Summarises business assets, liabilities and capital at a specific point in time
• Current assets


  Assets that can be converted into cash within one year
• Profit vs Cash


  Profit is the difference between revenue generated and the business costs. Cash is measured by taking into account the full range of money flowing in and out of a business over a period of time.
• A change in legislation can mean that products or processes may require significant redesign or withdrawal
• Internal causes of business failure

  • Poor planning
  • Lack of leadership
  • Ineffective marketing
  • Cash flow problems
  • Lack of funds
• Economic challenges like rising interest rates or a recession are a key cause of business failure
• Business failure


  When a business becomes insolvent and is unable to meet its financial obligations
• Cash is the most liquid of a business's current assets and can be used to settle debts immediately
• External causes of business failure

  • Economic challenges
  • Changes in consumer tastes
  • Legal factors
  • Market challenges
  • Technological change
• A lack of cash flow or working capital can cause swift business failure as it becomes difficult to operate on a day-to-day basis
• Insolvency


  The inability of a business to pay its debts and financial obligations when they are due