Finance - Unit 1

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  • Created by: Jmsmcn
  • Created on: 23-09-17 17:52

Business Costs

Revenue is the income earned by a business. They make revenue by selling products

Revenue = sales X price

Costs are expenses paid to run the business

Direct costs are costs that are a result of making a product (e.g. raw materials). Indirect costs are general business costs (management salaries). Fixed costs do not vary without output (rent). But they are only fixed over a short period of time a as the business grows so will the fixed costs. Variable costs increase with output (raw materials)

Total costs = variable costs + fixed costs

Average cost = total cost / output (the average cost usually falls as production increases because of the economies of scale)

Profit (or loss) is the difference between revenue and costs

Profit = revenue - costs

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Sources of Finance

Firms need start-up capital to buy things to run the business and to finance the inital poor cash flow. They need money to manage day to day costs and if they offer delayed payments. Money is needed to expand

Small firms have 5 main sources of finance:

Grants (money give to small businesses they do not have to pay back, from EU, governments and charities)

Trade Credit (gives the business one or two months to earn money to pay the company)

Overdrafts (they let the firm take out more money than it has in the bank but interest is high)

Loans (bank loans - quick and easy but have interest and may require collateral, friends and family - easy to get, mortgages - long term so interest is quite low but the property acts as collateral)

Venture Capital (money invested by individuals in return for a stake in the business)

It's hard to raise money as banks can be unwilling as it's risky, and they don't make much profit

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Help and Support

The government gives a lot of help as businesses create jobs so there is less unemployment and they will get more tax. The government funds Business Link which offers guidance on things like business plans. New firms can have bank loans underwritten by the government so they will pay the money if the business cannot so banks are more likely to lend money

Private firms offer support. For example banks. They offer financial support (loans) and offer advice. They do this to get the firms to open a bank account and to reduce the chance of the business going bankrupt.

Some firms exist to provide advice. They charge but provide it for free for new firms (they hope when the business is established they will use them again)

Some charaties offer advice and money because they believe businesses are good for society (Prince's Trust)

The chambers of commerce (group of business people) give information and support to local businesses.

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Cash Flow

Cash flow is the flow of money in and out of the business. When they sell things money flows in and when they buy things money flows out. Net cash flow is the difference between money flowing in and money flowing out.

A cash flow forecast is a good way of prediciting liquidity problems. The business can see when an overdraft may be needed. It is useful to know this in advance because it means the firm can plan and they will not panic

Bank balance at the end of the month = bank balanace at the start of the month + net cash flow

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Cash Flow - Credit

Credit terms can affect cash flow. Credit terms tell you how long after agreeing to buy a product the customer has to pay:

A turkey selling company makes lots of money in December but they have pay for them in October and November (when they do not make much money) so they may need an overdraft for a few months 

But if customers have 2 months to pay for the turkeys the money only comes in later (in February) so they may need a longer overdraft

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Cash Flow - Problems

If you have poor cashflow it menas you cannot meet the costs of running the business. Staff may not be paid on time (causing resentment and poor motiavtion). Suppliers may offer a discount for prompt payment (they would not get this). Creditors may insist on stricter credit terms if it takes a long time to may the money back, or the may take legal action and force the business to go into receivership.

There are 3 main reasons for poor cash flow:

Poor sales (lack of demand so you have less revenue), overtrading (takes too many orders so they order lots of materials and hire lots of staff but then something happens and they don't get the payment and so they don't have enough money to pay debts), and poor business decisions (a business expand but does not make much money, this is often because of a lack of market research)

3 ways they can improve cashflow:

Give customers less generous credit terms, get better credit terms from their suppliers (longer than the customer's credit term), sell unsold products to get capital.

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