Knowledge Organiser - 3.3 - Effective Financial Management - PowerPoint Presentation

1. Knowledge Organiser - 3.3 - Effective Financial ManagementWhat is profit?Profit is when the total revenues of a business are greater than its total costsWhat is cash flow?Cash flow is the movement of money into (inflows) and out of(outflows) the businessWhat is a cash outflow?It is money leaving the business. Also knows as payments. Examples of outflows are:Wages/salariesMaterialsTelephone billWhat is financial management?Financial management is deliberately changing monetary variables like cash flows to achieve financial objectivesHow can you reduce cash outflows?Order fewer materials and stockDelay paying invoices to suppliers because this improves a business’s cash flow position. However this is risky because suppliers might refuse to supply the business with productsLease rather than buy assets all at once. This reduces a business’s cash outflow. Change suppliers - but it could impact qualityHow is profit calculated?Profit is calculated as follows:Total revenue - Total costsWhat is breakeven?Breakeven is when total revenue = total costs. The business make £0. What is a cash inflow?It is money coming into the business. Also knows as receipts. Example of inflows are:Sales revenueBank loanWhat is net cash flow?Net cash flow formula is as follows:Total inflows - Total outflowsWhat is the opening balance?This is the balance (amount of money) the business has in its bank account at the beginning of the month. It’s the last month’s closing balance. What is the closing balance?This is the balance (amount of money) the business has in its bank account at the end of the month. Its calculated as follows:Net Cash Flow + Opening BalanceHow can you improve cash inflows?Take out a bank loan. Increase revenue by either increasing prices or increasing the quantity soldDe-stocking - make a reduction in prices to sell off stock e.g. like Next’s Christmas saleEmploy a debt factorChase up late payments from customers who buy on credit i.e. chase up your debtorsReduce the time given to debtors to paySell business assets like unused machineryIssue new company shares. This is only applicable to private and public limited companies. What is profit used for?Profit is used for the following reasons:Investment in research and development to improve product/serviceGrowth - buy new stores, launch new products etc. How can a business raise profits through cutting costs?Reduce material costsCut staff costsReduce investment in R&DReduce marketing How can a business raise profits through raising revenue?Improve marketing to increase demand and salesIntroduce better quality productsChange pricing Revenue = Price x Quantity Sold*The overall impact of a change in price depends on what happens to quantity of sales and costs. How do you calculate breakeven?Breakeven is: Fixed costs/Contribution per unitHow do you calculate contribution per unit?Contribution per unit is: Selling price - Variable cost per unitWhat is a fixed & variable cost?Fixed: A cost that doesn’t change with output e.g. salariesVariable: A cost that does change What’s the margin of safety (MoS)?This is the difference between the break-even point and the planned level of production/level of output. It lets the business know by how much sales could fall before a loss is made. The higher the MoS the lower the risk of the business failing. Margin of safety = Production - breakeven pointWhat’s the advantages of breakeven analysis?Helps business decision making i.e. you can see whether or not a business idea is sensible by calculating future costs and profitHelps with raising finance i.e. asking a loan from the bankShows the firm’s MoSYou can do a ‘what if’ analysis to see how an increase or decrease in price or costs impacts the b/e

2. What are the risks of not completing a breakeven analysis?The business could be making a loss and it doesn’t know and therefore no action is taken to fix itSelling price could be too low to cover total costs. Costs are unknown and could be too high - so the business idea may not be realisticHow will changes to price and costs affect the break even point?If the selling price increases then the breakeven point will fallIf the selling price decreases then the breakeven point will riseIf the variable cost per unit increases then the breakeven point will riseIf the variable cost per unit decreases then the breakeven point will fallIf the fixed costs increase then the breakeven point will riseIf the fixed costs decrease then the breakeven point will fallKnowledge Organiser - 3.3 - Effective Financial ManagementWhat is retained profit and what are its pros and cons when using it as a source of finance? Retained profit is money that is kept back from shareholders and put back into the business. It applies only to companies. Advantages:It can be used to finance future investments like opening new stores or pay off business debt.It’s generally a cheap form of borrowing as there's no interest paid. Its also generally risk free unlike a bank loanDisadvantages:Shareholders may be displeased because they are not paid dividends (their share of the profits) and could stop investing in the businessWhat is contribution?Contribution is the amount of money left after having paid variable costs to pay fixed costs. Its calculated by taking away selling price per unit from variable cost per unitWhat is internal sources of finance?This is finance that is obtained from within the business. Its main sources are:Selling assetsRetained profitWhat is external sources of finance?This is finance that is obtained from outside the business. Its main sources are:Bank loansOverdraftTrade creditBondsShare CapitalWhat is selling assets and what are its pros and cons when using it as a source of finance? Selling assets means is selling off under-used or unwanted assets like machinery or buildingsAdvantages:No interest has to be paidBusiness ownership isn’t dilutedIf no longer required - wont affect business operationsDisadvantages:You may need them in the futureWhat is an overdraft and what is its pros and cons when using it as a source of finance? An overdraft allows a businesses’ account to go into a negative balance for an agreed period of time and amount. These are short term loans. Advantages: Gives flexibility to businesses in case they are short of cash one month - the business can ‘dip’ into the overdraft to pay for short term billsDisadvantages: Like trade credit if you miss the deadline for a payment you will pay a feeWhat is trade credit and what is its pros and cons when using it as a source of finance? Trade credit is a short term source of finance given by suppliers. A business receives goods in advance and usually having 30 -45 days to pay for themAdvantages: It’s interest free and a cheap way of getting finance. You could also receive a discount for early paymentDisadvantages: Could cost you if you miss the deadline for paymentTrade credit terms are likely to be much stricter for smaller firms What are the limitations of the breakeven analysis?Assumes costs remain the same at each output level - but this isn’t the case due to ‘economies of scale’It’s a simplistic model that assumes a firm sells only 1 product - this isn’t the case for most businesses therefore the model isn’t ‘fit for purpose’ for large businesses What is share capital and what is its pros and cons when using it as a source of finance? Share capital is when companies sell shares to others to raise money Advantages:You can raise a large amount of money interest free. Its also quite risk free. Disadvantages:Owners can lose control of the business if they sell too many shares. Its called diluting the shareholding

3. Knowledge Organiser - 3.3 - Effective Financial ManagementWhat are bonds and what are their pros and cons when using it as a source of finance? It’s a long term loan where money is borrowed from companies or governments in exchange for regular interest payments. They can also be traded on a bonds market. Advantages:Regular interest paymentsDisadvantages:Inflation and exchange rates could reduce the value of their bondsNot applicable to small start-ups - mainly large businessesWhat is share capital and what is its pros and cons when using it as a source of finance? Share capital is when companies sell shares to others to raise money Advantages:You can raise a large amount of money interest free. Its also quite risk free. Disadvantages:Owners can lose control of the business if they sell too many shares. Its called diluting the shareholdingWhat is a bank loan and what is its pros and cons when using it as a source of finance? A bank loan is money borrowed from a bank that has to be paid back in instalments. These tend to be long term loans but not always. Advantages: You can raise a large amount of moneyDisadvantages: You will have to pau back interest which means you will pay back more than you received - overall. Businesses that have a lot of debt are likely to get into difficulty if they begin making big losses