LTD. Limited company - shares not available through the stock market.
Management accounting. Accounting statements that are produced to assist the company's marketing. Management accounts can be used for planning, decision making, review and control.
Margin of safety. The amount by which demand can fall before the company begins to make a loss.
Monopoly. A single product for a whole market.
One off profit. A surplus of money which is a result of an event which is unlikely to occur again in the future.
Opportunity costs. Measures the cost of the next best thing that a company has missed out on by choosing an alternative. It may or may not be measured in terms of money (Think of it as the opportunity cost of spending a night studying is going out to the cinema).
Overtrading. Occurs when a firm expands without the necessary long term finance so puts too great a strain on working capital.
PLC. Public limited company - shares are available to the public on the stock market.
Profit margin. A proportion of sales revenue which can be expressed as a total or on a per unit basis.
Security. Also known as collateral which is a means of making a loan secure by the borrower putting up land or property as a guarantee against failure to pay back loan.
Stock exchange. The market for trading securities (stocks and shares).
Variable costs. Costs which vary with output e.g. raw materials.
Venture capital. This is used for a medium sized business when they need extra capital but are unable or unwilling to float on the stock market.
Working capital. The day to day finance needed for running a business.
Zero budgeting. Setting budgets to zero each year and expecting budget holders to justify why they need the money in their budget.
Business plans are normally drawn up at the start of each year.
A business plan is used as a focus for the business which can also be used to set objectives.
The business plan is used to show people that are lending the business money, so they have an indication of the likely success of the business.
It can be used to monitor the businesses progress.
A good business plan includes the following:
Details of company,
Description of product,
Customer info,
Organisation and location,
How much money the business has,
Detailed analysis of cash available - cash flow forecasts etc.
A SWOT analysis is a very useful tool for a business. It identifies the strengths, weaknesses, opportunities and threats that face the business. Some of the ideas that can be included in a SWOT analysis are shown below:
Strengths (internal): Staff, experience, skills, product quality, finance, location.
Weaknesses (internal): Lack of finance, lack of skills, no experience.
Opportunities (external): Gap in the market, new market, location, strong economy.
Threats (external): Competition, new market, fashions and fads, declining market, legislation.
Costs are expenses the company has to pay during the production of its product. There are 3 main types of costs, these are: fixed costs, variable costs, and semi-variable costs:
Fixed costs:
Costs that don't change over a period of time and don't vary with output. E.g. salaries, rent, tax, insurance, heating and lighting. Fixed costs can also be called indirect costs as they are not directly associated with the final product. Fixed costs have to be paid even if the company is not producing any goods.
Variable costs:
Costs that vary directly with output so when output increases, variable costs also increase. E.g. raw materials, electricity. Variable costs can also be called direct costs as they are directly associated with production.
Semi-variable costs:
These costs have fixed and variable elements. E.g. a person working for the company may have a fixed salary but may also earn commission on sales.
Total costs are calculated by adding together fixed, variable and semi-variable costs.
Revenue is the money the company receives for selling their product or service. It is calculated by taking the selling price and multiplying it by the number of units sold.
Profit is the amount of money left over after costs have been covered. It is therefore calculated by: total revenue minus total costs. Profit can be used as a measure of the businesses success, attracting investors and reinvesting back into the business. The quality of profit can also be measured. Low quality profit is gaining money from an event which is unlikely to occur again in the future but high quality profit is from normal trading activities which should continue to occur in the future. It is important when told a company's profit, that it is clear what type of profit it is (gross, operating, pre-tax or after tax).
The break even point for a business is when the total revenue equals total costs. Break even graphs can be used to show total costs and total revenue; the point where the two lines cross is the break even point.
Break even analysis shows the level of sales that are needed to break even. It can also be used to investigate the impact of a price change or be presented to the bank with request for a loan.
Break even graphs can also be used to show the margin of safety. That is the amount by which demand can drop before the company makes losses.
There are some disadvantages of using a break even chart / graph:
It doesn't always account for changes .
Assumes that everything made is sold and that no stock is held.
It is dependent on accurate data.
Assumes that total cost and total revenue are straight lines (no bulk buying etc).
Cash flow is the measure of money flowing in and out of the business.
Cash flow problems are a regular reason for business failure.
Cash flow forecasts can be used to predict timings and amounts of cash shortages. This means the company can prepare for shortages of cash e.g. get an overdraft.
To manage cash flow, a company needs to delay and reduce outflows of cash and speed up inflows of cash to the business.
Increase inflows:
Give customers a shorter credit period.
Using a factoring company to chase up unpaid bills.
General good credit management.
Delay outflows:
Ask suppliers for a longer credit period.
Buy in bulk to take advantages of economies of scale.
Lease equipment instead of buying it.
JIT (just in time) means avoiding keeping excess stock so less space is used up.
Also, a company may reduce outflows by cutting costs or find cash to cover shortages such as a bank loan.
A firm may have excess cash but be unprofitable e.g. if they have just sold off a lot of old stock cheaply - made money from the sales but little profit.
A firm may be profitable but lacking cash e.g. if the amount they are spending is more than what they are receiving from sales.
Sources of finance
Finance is needed throughout a company's life. The type and amount of finance required for a business depends on many factors: type of business, success of firm and state of the economy. There are two main types of money that a company needs.
Capital expenditure: Used for buying fixed assets where large sums of money are involved but they are not purchased often e.g. new premises.
Working capital: Day to day money required for running the business.
There are two main sources of finance, these are internal sources and external sources.
Internal sources include:
Retained profit - profit made is reinvested into the business.
Controlling working capital - reducing costs, delaying outflows and speeding up inflows.
Sale of assets - Assets the company owns can be sold and then leased back which frees up a large amount of capital in the short term.
External sources of finance:
Increasing trade credit - delaying payments on purchases for as long as possible.
Factoring - use a company to collect all debts.
Overdraft - an agreement with a bank to be allowed to overdraw a certain amount.
Grants - an agreed amount of money given for a special reason by government or other organisation.
Venture capital - people invest in the company when it is unable to float on the stock market.
Debentures - business equivalent of a mortgage. Loan for a set length of time at a set interest rate.
Share issues - selling of new shares to raise capital.
Owners savings - the owners investing money into the business.
Bank loans - medium or long term loans but interest is charged.
Leasing - instead of buying.
Budgeting
A budget is a targeted amount of cost or revenue that the company will hope to achieve which can also be split up into certain departments of a company. A budget is drawn up by looking at past and present figures and then trying to predict future needs. Zero budgeting is a type of budgeting which starts afresh each year and does not just modify past figures.
A budget has many purposes:
Helps planning for the business.
Makes it easier to monitor the businesses progress.
Helps communication within the business.
Helps to motivate staff.
Helps establish the businesses priorities.
Problems with budgets:
May not allow for change and therefore be inaccurate.
No control over external factors.
May lead to demotivation of staff.
Budgets can be compared with actual outcomes to find the variance. A variance is known as adverse if the company is disadvantaged due to the variance. A variance is known as favourable if the company benefits due to the variance.
Cost and profit centres are used to look at the costs and profits caused by different departments or sections of a business. Each department or section is known as a centre.
Cost and profit centres may be used to divide up the fixed costs of a company into different departments.
Advantages of using cost and profit centres:
Helps achieve financial control.
Helps organise the business and give it structure.
Helps motivate staff in each centre.
