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1 Cashflow & Breakeven Special thanks to Geoff Leese.

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1 1 Cashflow & Breakeven Special thanks to Geoff Leese

2 2 Financial Aspects of Business n This block of six lectures covers financial aspects of business n The mission of all business is to make a profit n Clear monitoring and control is needed to ensure that this can happen n This means that you need to set up a good Information System from the start n These lectures cover the tools and skills necessary to monitor and control the money

3 3 Software n Businesses use software for their accounting n Excel spreadsheets are widely used for simple accounts. You need to know something about accounting to set up the sheets and use the functions n Specialist software also requires a knowledge of accounting practices. GIGO! n Sage software is a widely sold specialist range of accounting packages, for all sizes of business n Microsoft Money is inexpensive and popular for small businesses

4 4 Accounts n These are the profit and loss account and the balance sheet of a company n An account is a statement of indebtedness from one person or company to another n Companies are required by law to keep accounts, which are audited annually by persons who are members of an authorised body n Accounts are kept in books (see Excel terminology), hence bookkeeping

5 5 Topics in this lecture n The Flow of Money n The Death Valley curve n Managing cash flow n Break even analysis and “contribution”

6 6 The flow of money Obtain capital: own capital, share capital, loans Operating profit Buy assets: fixed and current Sales Net profit Retained profit Withdrawals or dividends Taxation Loan interest and other non- routine costs Day-to-day operating costs Money leaving the business

7 7 The six financial drivers of small firms n SALESDaily/weekly/monthly n CASHDaily/weekly/monthly n PROFIT MARGINSMonthly n MARGIN OF SAFETY or BREAK-EVENMonthly n DEBTORS or STOCK TURNOVER Monthly n PRODUCTIVITY (wages:sales)Monthly UPDATE INFORMATION

8 8 Death Valley curve Business launch Establish business and find customers First Sale TIME Sales £- CASH £+ £0 Maximum borrowing Cash flow

9 9 Death Valley n The venture capital belonging to a firm is used during start-up, and can run out before its income reaches predicted levels n Leaching of capital makes it difficult for the company to obtain any further investors who can provide additional venture capital n 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 10 Cash flow n 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 n You can be making a profit and still run out of cash which means that bills go unpaid n Start ups face the danger of Death Valley n Cash flow projection lists all expected payments and receipts over a stated period n Managers use cash flow projections to plan payments of creditors (and employees)

11 11 Managing cash flow Cash in bank Money you owe your creditors 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 owed to you by your debtors Stocks - Current liabilities Current assets Minimise Maximise credit terms Overall increase in cash available Minimise

12 12 Managing cash flow Debtors - minimise outstanding debt Creditors - maximise credit terms Stocks - minimise stock levels

13 13 n Choosing ä Trade references ä Bank references ä Published information ä Credit checks ä Sales visits n Limits ä Amounts ä Time allowed ä Obtain stage payments Choose credit customers and set credit limits Debtor control / 1

14 14 If all else fails: n Withhold supplies n Try reclaiming goods n Consider using debt collectors n Take legal action Tips on speeding up payments cont. Debtor control / 2

15 15 Stock control n Have a reliable system that accurately reflects practice n Ensure correct costings n Ensure easy to use n Ensure everyone uses it n Aim at JIT n Centralise system in small firm n Police system and avoid shrinkage – everything must be paid for in monetary terms or paper accounts

16 16 Creditor control / 1 n Agree best possible credit terms with suppliers and stick to them n Do not pay early n Establish key suppliers and make certain they are paid on time n Take repeat business to suppliers where possible to develop relationship

17 17 Creditor control / 2 n 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 18 Insolvency n Inability to pay debts when they are due ä Shows need for good cash flow analysis n Individuals – may lead to bankruptcy n Companies – may lead to liquidation n Trustee in bankruptcy or liquidator – specialist – appointed n Gathers and disposes of all assets available, to pay creditors

19 19 Breakeven analysis n Cost-volume-profit analysis CVP n Costs analysed into fixed costs and variable costs n Compared with potential sales revenue to determine the output level at which the business makes neither a profit or a loss (breakeven point) n Unit contribution is sale price less variable cost; when total contributions exceed fixed overheads, all further contribution is profit

20 20 Some Definitions n Total costs = variable costs + fixed costs n Variable costs are related to each item sold (usually direct materials and labour) n Fixed costs are all other costs n Revenue = selling price * volume sold n Breakeven point = the volume of sales at which the total costs are equal to revenue

21 21 Cost–profit–volume chart Output volume Cost or revenue £ Total revenue Total costs B A Target profit XY C Break-even point C

22 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

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