APPLY KNOWLEDGE AND UNDERSTANDING OF HOW THE MANAGEMENT OF FINANCE CONTRIBUTES TO THE SUCCESS OF SMALL AND MEDIUM SIZED ORGANISATIONS.

N5 MPF 2.1: Describe sources of finance and outline their costs and benefits.

BiA 1.4 - Describe sources of business finance and support when setting up a small business.

N5 MPF 2.2: Interpret a break-even chart.

IoB 2.1 – Interpret a simple cash budget or break-even chart in order to reach a decision.

N5 MPF 2.3: Interpret a cash budget to identify cash flow issues and outline appropriate solutions.

IoB 2.1 – Interpret a simple cash budget or break-even chart in order to reach a decision.

N5 MPF 2.4: Prepare a simple profit and loss statement from data provided.

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IoB 2.2 - Interpret a simple job costing statement from data provided in order to reach a decision.

N5 MPF – Describe the role of technology in managing people and finance.

N4 BiA 3.1: Describe the way in which each of the functional activities of marketing, operations, human resources and finance support a small business.

N4 BiA 3.2 – Outline how two functional activities work together in supporting small businesses.

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N5 MPF 2.1: Describe sources of finance and outline their costs and benefits.

BiA 1.4 - Describe sources of business finance and support when setting up a small business.

SOURCES OF FINANCE – PRIVATE SECTOR ORGANISATIONS

Business organisations of all types need to raise finance to start up, maintain and/or expand their activities. Once an organisation is up and running, it will need to become self-financing by using its income to sales to cover its operating costs.

Profits can be retained and built up over time to finance improvements and growth in the business. This type of finance is called internal finance.

Other sources of finance can come from external sources and can be long, medium or short term. The type of finance raised depends on the type of business organisation and on the use to which the finance will be put.

LONG-TERM SOURCES OF FINANCE

Source of Finance Advantages Disadvantages

Owners’ Investment - increase the amount of personal money invested in the business by the owner (sole trader or partner). Selling more shares of ownership (private limited company).

The money does not have to be repaid unless the business is wound up.

Profits have to be shared out with more people. Risk of losing control of the business. Risk of losing investment if the business fails (unlimited liability or sole trader or partners).

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Bank Loan – money borrowed and repaid in instalments. Interest is paid on the loan. A loan secured on property is called a mortgage. Sole traders or partners may be able to secure loans off family and friends.

Profits do not have to be shared between as many people as no ownership is given up.

Loans secured from family and friends may have low or no interest and flexible repayment periods.

Interest payments must be made over the life of the loan, which increases the running costs of the business.

The money must eventually be repaid which may create cash flow problems.

Grants – from government or charitable organisations eg PSYBT – are monies that are given over in return for meeting certain conditions eg to locate in a particular area or offer employment and training to certain numbers of people.

Grants do not need to be repaid at any point and do not involve the sharing of ownership.

There are no interest payments or other charges on the grant.

The organisation may be restricted in how it can use the grant money – certain conditions may have to be complied with.

MEDIUM TERM SOURCES OF FINANCE

Source of Finance Advantages Disadvantages4

Hire Purchase – used by any type of business to buy fixed assets (machinery, equipment). Repayments are scheduled over a period of time.

The business can acquire up-to-date machinery and equipment without having to offer security for a loan as the equipment is the security. Payments are spread out over years, thus helping cash flow.

Interest rates are higher than a bank loan and if the business defaults on the repayment, it may lose the equipment even if they have paid a lot of it up.

Leasing – the organisation rents equipment, vehicles for an set period of time.

The business will not have to meet repairs and will always have up to date equipment / vehicles.

The equipment or vehicles never become the property of the business.

SHORT-TERM SOURCES OF FINANCE

Source of Finance Advantages Disadvantages

Overdraft - a short term arrangement with the bank which allows the business to spend more money than it has in its account.

Overdrafts can be agreed in advance, and do not need to be secured on an asset.

Interest rates are very high and the funds are usually only available for a short period of time.

Trade Credit - suppliers give an organisation a period of time between supplying the goods and having to pay for them.

Businesses have time to sell stock before they pay up, thus improving cash flow.

Credit terms are short – 30-60 days – and need to be managed to ensure that customers are settling their accounts before the business has to settle up with its supplier.

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N5 MPF 2.2: Interpret a break-even chart.

IoB 2.1 – Interpret a simple cash budget or break-even chart in order to reach a decision.

BREAK-EVEN POINT

Break-even Point is a calculation used by businesses to work out the number of sales they need to make to cover their total cost.

COSTS AND REVENUE

Before we can calculate our Break-Even Point, we first need to understand the kinds of costs we have in our business. These costs can be grouped in to 2 main types:

Fixed Costs

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If I know I can only produce a maximum of 500 cakes a day, but my calculations show I need to bake 600 a day to break-even, there’s no point in me starting up my business. I will make a loss instead of a profit.

Variable Costs

FIXED COSTS are costs that do not change regardless of how much the company produces or sells.

An example might be a bakery - even if they produce no products in any given week, they still have to pay expenses such as rent, manager’s salaries, rates to the local council, telephone line rental, etc.

VARIABLE COSTS are costs that change according to the volume or production or sales.

If the bakery produces no goods in any given week, their variable costs (ingredients, electricity to power the ovens, etc) would be zero. If they increased production to produce 10,000 loaves another week, then the variable costs would rise because they were using more of the resources required for production.

TOTAL COSTS – these are the sum of the fixed costs and the variable costs.

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TOTAL REVENUE – this is the income from sales, calculated by the Selling Price x Number of Sales made. This is sometimes referred to as ‘Sales Revenue’.

Information presented in a graph…

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N5 MPF 2.3: Interpret a cash budget to identify cash flow issues and outline appropriate solutions.

IoB 2.1 – Interpret a simple cash budget or break-even chart in order to reach a decision.

IMPORTANCE OF CASH FLOW & BUDGETING

To reduce the risk of making poor financial decisions, a business may prepare a Cash Budget (Cash Flow Statement) so that it can monitor and predict the effects of financial decisions.

Cash flow is the amount of cash (or cheques / direct bank payments) that come into and out of the business.

In a business organisation, cash flows in from a variety of sources eg capital invested by the owner(s), sales revenue, bank loans, grants etc.

Cash flows out of the business when it has to cover costs such as staff wages, rent, insurance, delivery charges, telephone, gas & electric bills, buying stock or raw materials, loan interest and repayments etc.

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Problems arise when the business has less cash coming in, compared to what it has going out. In general terms, the business must do at least one of two things:

Increase the amount of cash coming in to the business

Decrease the amount of cash going out of the business

CASH BUDGETS

To monitor and therefore control cash flows into and out of the business, a budget should be prepared. A budget is a plan or forecast that is prepared in advance.

A cash budget shows cash (or bank receipts) that are likely to come in and how it will be spent over the coming months or year. It does not show if the business is making a profit or loss.

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Cash Budget – Key Features

Opening Balance – cash (bank balance) available at the start of the budget period.

Receipts – cash/bank receipts for any reason – loans, investment, grants, sales.

Payments – any cash/bank payments for any reason – loan repayments, interest, stock, day to day running costs such as wages, rent, insurance, purchases of new equipment.

Closing Balance – the Opening Balance + Receipts – Payments – the amount of cash (bank balance) left at the end of a month.

The closing balance at the end of one month carries forward to become the opening balance at the start of the following month.

Advantages of Cash Budgets

Targets - Budgets can give targets to work towards. For example, a business may set a target of increasing sales income by 10% by the end of the year.

Control – Budgets help control a business’s spending. 11

Planning - A cash budget helps to anticipate forthcoming difficulties before they happen eg a shortage of cash.

CAUSES OF CASH FLOW PROBLEMS

METHODS OF IMPROVING CASH FLOW

Falling sales revenue – the product may be in the decline stage of its life cycle, or may have fallen victim to the effects of a recession or competitor action.

Cost Effective Marketing Measures – to shift stock and increase sales volumes falling sales eg a ‘buy one get one free’ offer, price reduction, low cost advertising eg handing out flyers or web-based advertising.

Sudden (unexpected) increases in running costs (expenses) eg due to an increase in the minimum wage, rising interest rates, fuel costs, suppliers put their prices up without warning.

Reduce Staffing Costs – release workers employed on temporary contracts or reduce the working hours of staff on casual (‘zero hours’) contracts.

Efficiency Savings – more careful use of resources eg electricity (may involve switching suppliers), using off-peak utilities, changing delivery methods.

Seek Cheaper Supplier of Stock – shop around for a better deal of supplies of raw materials and other stocks – possibly even sourcing suppliers abroad.

Not enough start-up finance – the business did not raise enough finance to see it through the early stages trading until sales revenue has built up enough.

Take a Loan – from a bank or family or friends. The loan could be long term eg to buy equipment, or short term (overdraft) to settle bills with Creditors until cash flow improves.

Raise Extra Capital – re-invest profits, issuing shares, owner invests more funds or take on a partner.

The business has bought too much stock at one time – perhaps to secure a bulk-buy price discount – but is not selling the stock quickly enough and is also now experiencing higher storage and security costs.

Reschedule Payments – seek longer periods of credit from suppliers. This will reduce the outflow until cash has been received from customers. However, suppliers may not agree to this as they have to manage their own cash flow.

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Too high expenditure on machinery or equipment – especially if bought ‘outright’.

Spreading Equipment Costs – hire purchase or leasing instead of buying. This will mean that the outflow of cash will be spread over a number of months.

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N5 MPF 2.4: Prepare a simple profit and loss statement from data provided.

IoB 2.2 - Interpret a simple job costing statement from data provided in order to reach a decision.

CALCULATING THE PROFIT OF THE BUSINESS

Most businesses will aim to make a profit on their business activities. Profit is the difference between the revenue received from the sale of a good or service and the cost of providing the good or service.

A number of accounts are prepared for a business at the end of each financial year to calculate how much profit the company has made.

Trading Account Shows the Gross Profit - the difference between Sales Revenue (the amount of money taken in from selling goods) and the Cost of Sales (how much it cost the company to buy in stock, etc to sell on to

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Profit =

customers).

Profit & Loss Account

Shows the Net Profit – the amount of money the business makes after it has taken off its other bills or expenses eg wages, electricity, advertising, etc.

TERMS USED IN THE TRADING, PROFIT AND LOSS ACCOUNT

Sales Revenue Income from sales of goods and services (Price x Number of Sales).

Purchases The amount spent during the year purchasing stock for resale to customers.

Cost of Sales (or ‘Cost of Goods Sold’)

True cost of stock that has been sold at cost price.

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Gross Profit Profit made on Sales income less the cost of sales. This is before expenses have been deducted.

Expenses Daily running costs of the business eg wages, electricity, advertising, rent,etc.

Net Profit Final profit of the business taking account of all costs and expenses.

MEASURES TO IMPROVE GROSS PROFIT AND NET PROFIT

Improving Gross Profit

Increased sales income through better marketing activities.

Increase selling price so that more Gross Profit can be made on each unit of sale.

Reduce Cost of Sales by finding a cheaper supplier of stock / raw materials or by negotiating a bulk buy discount.

Improving Net Profit

Reduce wage bill eg reduce working hours of temporary workers or make permanent staff redundant.

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Reduce admin costs eg make better use of ICT.

Shop around for cheaper electricity, telephone and other services.

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N5 MPF – Describe the role of technology in managing people and finance.

SPREADSHEETS

Spreadsheets can be used to calculate Trading Account, Profit & Loss Account, Cash Budgets / Budget Statements or Break-Even Analysis.

Through the use of formula, calculations will be accurate and will update automatically.

Spreadsheet charting functions can be used to prepare Break-Even Charts.

By linking spreadsheet functions to stock control (bar code scanning), accurate records of stock can be maintained.

WORD PROCESSING

Word Processing may be used to prepare financial reports to present to shareholders, or potential investors eg a Business Plan.

E-MAIL / INTRANET

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E-mail used to communicate financial information and decisions to budget holders.

Use of an Intranet (internal network) to allow sharing of financial information, allowing monitoring and control of departmental spending between branches and departments.

POWERPOINT

Use of a PowerPoint presentation to present end of year financial information to shareholders at the Annual General Meeting.

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