- Contribution= selling price - variable costs
- Total contribution= sales revenue - total variable costs
- Break even= fixed costs/contribution
- Break even output= fixed costs/contribution per unit
- Profit/Loss= total revenue - total costs
- Total costs= fixed costs + variable costs
- Closing balance= opening balance + cash inflows - cash outflows
- Added value= selling price - cost of inputs - cost of transformation
- Net monthly cash flow= cash inflows - cash outflows
- Total revenue= price per unit x quantity of units sold
- Market share= sales of firm/total market sales x 100
- Market size= number of units sold x price
- Market growth= change in size of market/original size x 100
Sources of finance
Ordinary share capital is money given to a company to shareholders in return for a share certificate. This gives them part ownership of the company and entitles them to a share of the profits. Ownership of 51% of the shares in a company gaurantees overall control of that company.
- Limited liability encourages shareholders to invest in the business as it restricts the amount of money they can lose.
- It is not necessary to pay shareholders a dividend if the business cannot afford these payments.
- Bringing new shareholders into a small business can often mean that further expertise is brought into the business.
- Increasing ordinary share capital can make it easier to borrow more funds from a bank, as the share capital can purchase assets that can be used as collateral.
- It does not need to be repaid, so it eases the pressure on a limited company.
- In profitable years, ordinary shareholders will expect good dividends and this is likely to be more expensive than the interest charged on a loan.
- The original aims of a business may be lost, as new shareholders may not have the same values as the owner.
- As more shares are sold to raise finance, the original owners may lose control of the business.
Sources of finance
Loan capital is money recieved by an organisation in return for the organisation's agreement to pay interest during the period of the loan and to repay the loan within an agreed time.
A bank loan is a sum of money given to a firm/individual by a bank for a specific, agreed purpose.
- The interest rate and thus the repayments are fixed in advance, making it easy to budget the schedule for repayments.
- Interest rates are normally lower because of the security provided.
- The size of the loan and the period of repayment can be organised to match the exact needs of the firm.
- The size of the loan may be limited by the amount of collateral than can be provided rather than by the amount of money needed by the business.
- It is often difficult or costly to repay a loan early.
- Start-ups are often charged higher rates of interest because they are unable to provide the guarantees that the bank manager might like.
Sources of finance
A Bank overdraft is when a bank allows an organisation to overspend its current account at the bank up to an agreed (overdraft) limit and for a stated time period.
- They are extremely flexible and useful for temporary cash-flow problems.
- Interest is only paid on the amount of the overdraft being used.
- They are particularly useful to seasonal businesses, which are likely to experience some cash-flow problems at certain times of the year.
- Security is not usually required.
- The interest rate charged is usually higher than for a loan.
- Banks can demand immediate repayment (although this is rare).
Sources of finance
Venture capital is finance that is provided to small or medium-sized firms that seek growth, but which may be considered as risky by typical share buyers or other lenders.
- Venture capital is available to firms that are unable to get finance from other sources because of the risk involved.
- Venture capitalists sometimes allow interest or dividends to be delayed.
- They may provide advice and guidance.
- Venture capitalists often want a significant share of the business in return.
- Venture capitalists often want high interest payments or dividends.
- It is possible that venture capitalists will exert too much influence, so the original owner may lose their independence.
Sources of finance
Personal savings: advantages
- This is a cheap source.
- It enables the owners to keep control of the business.
Personal savings: disadvantages
- A person can quickly lose their savings.
- The entrepreneurs may not have sufficient savings to finance a new business.
- A second mortgage may enable a homeowner to raise a substantial sum of money.
- The interest rates charged on mortgages tend to be lower than on other loans.
- If the business is unsuccessful, the owner may lose their property.
- Many entrepreneurs will not own a sufficiently valuable property.
Sources of finance
Private borrowing from friends and family: advantages
- Friends and family may be prepared to lend money when the bank would refuse.
- Friends and family often provide easier repayment terms.
- The additional money raised through friends and family may encourage a bank manager to offer a further loan.
- Owing money to friends and family can increase stress.
- It can undermine friendships, as there may be disputes about when and how much money should be repaid.
Selling private assets: advantages
- This may mean that an asset that was previously of no real use to a person is used productively.
- It is possible that the asset can be leased back by the owner and still used.
- This can cause family tensions, as the business may be seen to be benefiting at the expense of the family.
- It is unlikely that large sums of money can be raised by selling off private assets.
Usefulness of breakeven analysis
- A new firm can use breakeven analysis to calculate how long it will take to reach the level of output needed to make a profit.
- As a result, the business can predict its likely profit level.
- Breakeven analysis is particularly important to start-up businesses as it is a simple, straightforward way of discovering whether a business plan is likely to succeed financially.
- The data can be used as a key element in persuading bank managers or investors to give financial support to the start-up.
- Usually a start-up will use breakeven analysis to plan its expected results but also a 'best case' scenario and a 'worst case' scenario. This information can indicate the level of risk involved in the start-up.
- Breakeven analysis allows a firm to use 'what if?' analysis to show the different breakeven outputs and the changes in levels of profit that might arise from changes in its price or fixed costs or variable costs.
- The calculations are quick and easy to complete thus saving businesses time.
Weaknesses of breakeven analysis
- The information may be unreliable.
- The assumption that sales will equal output is a major weakness of breakeven analysis. It is likely that some output will remain unsold.
- In practice, the selling price may change as more is bought and sold.
- Fixed costs may not stay the same as output changes. At particular levels of output, new machines and even new buildings may need to be purchased.
- The analysis assumes that variable costs per unit are always the same, ignoring factors such as buying in bulk.
Cash flow forecast
Possible causes of inaccuracy in a cash flow forecast
- Changes in the economy
- Changes in consumer tastes
- Inaccurate market research
- Actions by competitors
Why businesses forecast cash flow
- To indentify potential cash flow problems in advance.
- To guide the firm towards appropriate action.
- To make sure that there is sufficient cash available to pay suppliers and creditors and to make other payments.
- To provide evidence in support of a request for financial assistance (e.g. asking a bank for an overdraft).
- To avoid the possibility of the company being forced out of business (into liquidation) because of a forthcoming shortage of money.
- To indentify the possibility of holiding too much cash - this probably means that a firm has less machinery and stock than it could possess, which gives the firm less output and strock to sell, so it makes less profit.
Planning a budget
- Stage 1:set objectives.
- Stage 2:carry out market research into demand and price.
- Stage 3:carry out research into costs.
- Stage 4:complete the sales (income) budget - gives an idea of the amount to produce.
- Stage 5:construct the expenditure budget based on this level of production.
- Stage 6:combine stages 4 and 5 to set a profit budget.
- Stage 7:draw up divisional or departmental budgets (usually delegated to managers).
- Stage 8:summarise these budgets in the master budget.
Methods of setting a budget
- Budgeting according to company objectives. The more ambitious the objectives, the greater the budget that needs to be allocated.
- Budgeting according to competitors' spending. In order to stay competitive, a business may have to match the spending of its rivals.
- Setting the budget as a percentage of sales revenue. Although this is less scientific, it is commonly used because it is seen to be fair.
- Zero budgeting/budgeting based on expected outcomes. In effect, this method allocates a budget on the strength of the case presented by the product manager.
- Budgeting according to last year's budget allocation. The logic behind this approach is that, if it was suitable last year, it will be suitable this year.
Reasons for setting budgets
- To gain financial support from bank managers and other investors.
- To control spending so that a business does not overspend.
- To establish priorities by allocating larger budgets to important activities.
- To encourage delegation and to motivate staff.
- To assign responsibility and so makes it much easier to trace mistakes or recognise to who credit should be given.
- To improve efficiency.
Problems in setting budgets
- Managers may not know enough about the division or department.
- Gathering information can be difficult for a start-up business.
- There may be unforeseen changes.
- The level of inflation (price rises) is not easy to predict.
- Setting a budget can be time consuming.