topic 6

• 5 reasons firms need finance

  for start up capital - the money or assets needed to set up a business

  new firms often have poor initial cash flows- meaning they find it hard to cover up their costs, so need additional finance for this

  sometimes customers delay payment, so finance is needed to cover this shortfall in liquidity.

  if a business is struggling it might need finance to reach its day to day running costs

  need finance too expand
• smaller firms have several sources of start up finance

  government grants- don't have to be repaid.

  short term sources:

  trade credit- businesses can be given 1 or 2 months to pay purchases.

  overdrafts- let the firm take more money out of bank account then is in it.

  long term sources:

  loans- bank loans, mortgages , interest payments

  hire purchases- this is when a firm buys something by first paying a deposit then paying the rest over time
• established firms have other sources of funds available

  retained profits- profits owner has decided to put back into business after they have Pais themselves a dividend.

  fixed assets- firms can raise money buy selling fixed assets ( assets a business keeps in a long term ) that are no longer in use

  new share issues - a limited company can issue more shares
• finance can be classed as internal or external


  internal finance- comes from inside the business. saves borrowing and paying interest. examples are personal or business savings, retained profits selling fixed assets

  external finance - comes from outside the business. usually has to be paid back. examples are bank loans, overdrafts or mortgages.

  loans from family and friends

  new share issues

  trade credit

  government grants

  hire purchases
• four factors affect the choice of finance

  size and type of company

  amount of money needed - company would issue more shares to buy a toaster.

  length of time the finance is needed for

  cost of finance
• businesses have to make investments 


  an investment is money which is put into a business to make improvements in order to make it more profitable.

  examples of investments:

  new machinery

  new buildings

  new vehicles

  spending more money can be risky as investment might not be profitable.

  so business has to make sure it is profitable, this is done by calculation return on an investment
• you can find the average rate of return on an investment

  the return on an investment is how much the business makes or loses as a proportion of the original investment that is put in.

  average rate of return = average annual profit/ initial investment X 100
• revenue 


  amount of money business earns
• COSTS


  amount of money business has to spend
• profit


  money left over after costs are taken away
• loss


  when costs are greater then the revenue
• fixed cost


  costs that don't change. e.g rent
• variable cost


  cost that increase as output increases. e.g raw mats
• breaking Even means covering your costs

  the break even output is the level of output needed to cover the costs

  new business should do a break even analysis to find the break even output
• break even output in a chart is found where total revenue meets total costs
• finding Margin of safety

  can use break even chart to calculate margin of safety

  margin of safety is the gap between the current level of output and the break even output
• break even analysis advantages


  easy to work out

  it is quick

  allows business to predict how changes in sales may effect things

  businesses can use break even analysis to help persuade a bank to give them a loan

  can stop businesses from releasing products that can be difficult to sell in large quantities
• break even output disadvantages


  assumes the firm can sell any quantity of the product at the current price

  break even analysis assumes all products are sold without waste

  if data is wrong, results of analysis can be wrong

  can be complicated if involves more then one product

  only shows how much a business needs to sell and not how much it will actually sell
• cash flow forecast


  shows all the money that's coming into and going out of a business.
• cash and profit 


  cash is the money a business can spend immediately, profit is the amount of money a company earns after costs have been taken into account
• cash flow


  the flow of all money into and out of a business
• net clash flow


  difference between cash inflow and cash outflow
• cash flow forecast help to anticipate problems


  is a good way of predicting when a firm might have a liquidity problem. ( lack of cash ).

  the firm will see when a short term of finance might be needed
• credit firms can affect cash flow


  credit firms tell you how long after agreeing to buy a product the customer has to pay. this can affect timing of cash flows.
• poor cash flows means you got big problems

  staff might not get paid on time- causing poor motivation

  creditors may not get paid on time

  some creditors might not wait and take legal action

  some suppliers offer discounts for prompt payments
• three main reasons for poor cash flow

  poor sales

  overtrading- firm takes on to many orders, as a result buys to many mats and hires to many staff. something goes wrong with the orders and the firm doesn't get the money from customers quickly enough to pay debt

  poor business decisions
• ways to improve cash flow


  rescheduling payments - for example giving customers less generous credit terms.

  
  

  reducing cash outflow- spending less on mats

  
  

  arranging to have an overdraft with their bank

  finding other sources of finance

  increasing cash inflow- increase selling prce
• income statement 


  type of financial statement showing how income has changed over time.
• first part to income statement: trading account

  this records firms growth profit or loss

  revenue is the value of all products sold in given period of time

  cost of sales- records how much it costs to make the products sold during the year- the direct costs.

  gross profit is the difference between the revenue and the direct cost.

  gross profit = revenue - direct costs
• second part of income statement: profit and loss account


  records all indirect costs of running the business

  doesn't cover cost of manichery but covers depreciation.

  depreciation is the amount of value which an asset has lost over a period of time due to wear and tear

  the money left after paying all the indirect cost is called operating profit

  any interest paid or received is included. what is left is called net profit
• third part of income statement: the appropriation account

  only included for limited company accounts

  records where the profit has gone
• gross profit margin 


  is the fraction of every pound spent by customers that doesn't go directly towards making the product

  gross profit margin = gross profit/ sales X 100
• net profit margin


  is the fraction of every pound spent by customers that the company gets to keep

  net profit Margin = net profit / sales X 100
• statement of financial position 


  records where the business got its money from, and what it has done with it
• fixed assets will last more then a year
• current assets last a few months

  they are listed in increasing order of liquidity in the statement of financial position:

  stock is the least liquid

  debtors is next. referring to value of products sold

  cash is the most liquid
• current liabilities are bills that firms have to pay soon
• current assets - current liabilities = net current assets

  net current assets is money available for the day to day operating in a business.