1

Cashflow & Breakeven

Special thanks to Geoff Leese

2

Financial Aspects of Business

This block of six lectures covers financial aspects of business

The mission of all business is to make a profit

Clear monitoring and control is needed to ensure that this can happen

This means that you need to set up a good Information System from the start

These lectures cover the tools and skills necessary to monitor and control the money

3

Software

Businesses use software for their accounting

Excel spreadsheets are widely used for simple accounts. You need to know something about accounting to set up the sheets and use the functions

Specialist software also requires a knowledge of accounting practices. GIGO!

Sage software is a widely sold specialist range of accounting packages, for all sizes of business

Microsoft Money is inexpensive and popular for small businesses

4

Accounts

These are the profit and loss account and the balance sheet of a company

An account is a statement of indebtedness from one person or company to another

Companies are required by law to keep accounts, which are audited annually by persons who are members of an authorised body

Accounts are kept in books (see Excel terminology), hence bookkeeping

5

Topics in this lecture The Flow of Money

The Death Valley curve

Managing cash flow

Break even analysis and “contribution”

6

The flow of moneyThe flow of money

Obtain capital: own capital, share capital, loans

Operating profit

Buy assets:fixed and current

SalesNet profit

Retained profit Withdrawals or dividends

Taxation

Loan interest and other non-routine costs

Day-to-day operating

costs

Money leaving the business

7

The six financial drivers of small firms

SALES Daily/weekly/monthly

CASH Daily/weekly/monthly

PROFIT MARGINS Monthly

MARGIN OF SAFETY or BREAK-EVEN Monthly

DEBTORS or STOCK TURNOVER Monthly

PRODUCTIVITY (wages:sales) Monthly

UPDATE INFORMATION

8

Death Valley curveDeath Valley curve

Businesslaunch

Establish businessand find

customers

First Sale

TIME

Sales

£-

CASH£+

£0

Maximum borrowing

Cash flow

9

Death Valley

The venture capital belonging to a firm is used during start-up, and can run out before its income reaches predicted levels

Leaching of capital makes it difficult for the company to obtain any further investors who can provide additional venture capital

Maximum slippage is the period between the start of earned income and the date to which the venture capital will support it, before heading to death valley

10

Cash flow Cash flow is the life blood of a business; it

pays all the bills, including salaries and wages. But many firms run low, particularly small businesses

You can be making a profit and still run out of cash which means that bills go unpaid

Start ups face the danger of Death Valley Cash flow projection lists all expected

payments and receipts over a stated period

Managers use cash flow projections to plan payments of creditors (and employees)

11

Managing cash flow

Cash in bank

Money youowe yourcreditors

Your (company) working capital is the amount of cash needed to keep the business going on a day to day basis. I.e. tied up in stocks + debtors, + cash in bank, and - what is owed to creditors. To minimise borrowing and ensure the maximum money is available for investment (or paying yourself) the working capital needed to be as low as possible

Money owedto you by

your debtors

Stocks

-Current liabilitiesCurrent assets

MinimiseMaximise

creditterms

Overall

increase in cash

available

Minimise

12

Managing cash flow

Debtors - minimise outstanding debt

Creditors - maximise credit terms

Stocks - minimise stock levels

13

Choosing

Trade references

Bank references

Published information

Credit checks

Sales visits

Limits

Amounts

Time allowed

Obtain stage

payments

Choose credit customers and set credit limitsChoose credit customers and set credit limits

Debtor control / 1

14

If all else fails:

Withhold supplies

Try reclaiming goods

Consider using debt collectors

Take legal action

Tips on speeding up payments cont.

Debtor control / 2

15

Stock control Have a reliable system that accurately

reflects practice Ensure correct costings Ensure easy to use Ensure everyone uses it Aim at JIT Centralise system in small firm Police system and avoid shrinkage –

everything must be paid for in monetary terms or paper accounts

16

Creditor control / 1

Agree best possible credit terms with suppliers and stick to them

Do not pay early

Establish key suppliers and make certain they are paid on time

Take repeat business to suppliers where possible to develop relationship

17

Creditor control / 2

If there are problems:

Work with creditors (eg agree part payments)

Keep bank informed

Remember that the Inland Revenue and Customs and Excise are the most likely organisations to put a firm into liquidation, so keep them informed and paid

18

Insolvency

Inability to pay debts when they are due Shows need for good cash flow analysis

Individuals – may lead to bankruptcy Companies – may lead to liquidation Trustee in bankruptcy or liquidator –

specialist – appointed Gathers and disposes of all assets

available, to pay creditors

19

Breakeven analysis

Cost-volume-profit analysis CVP Costs analysed into fixed costs and

variable costs Compared with potential sales revenue

to determine the output level at which the business makes neither a profit or a loss (breakeven point)

Unit contribution is sale price less variable cost; when total contributions exceed fixed overheads, all further contribution is profit

20

Some Definitions

Total costs = variable costs + fixed costs

Variable costs are related to each item sold (usually direct materials and labour)

Fixed costs are all other costs

Revenue = selling price * volume sold

Breakeven point = the volume of sales at which the total costs are equal to revenue

21

Cost–profit–volume chart

Output volume

Cost or revenue £

Total revenue

Total costs

B

A

Target profit

X Y

C Break-even pointC

22

Output volume

Cost or revenue £

X2

C2

X3X1

C3

C1

V1

V2 V3

Contribution (C) = Revenue-Variable cost ( R-V)

R3

R2

R1

Fixed costs

Variable costs

Total costs

Revenue