BM Unit 2 - LO31 Higher Business Management Business Decision Areas II Learning Outcome 1 Finance

BM Unit 2 - LO32 The ROLE of Finance n Prepare and monitor information (to allow decision making) n Maintain financial records n Pay bills, control credit n Pay wages and salaries n Analyse financial information n Produce Final Accounts

BM Unit 2 - LO33 The Importance of Finance n to control costs and expenditure n to monitor cash flow n to forecast trends n to monitor performance n to inform decision making

BM Unit 2 - LO34 Cash Flow Liquidity - having sufficient “cash” to meet everyday running costs

BM Unit 2 - LO35 Cash Flow Cash in  n Profit n Sales of fixed assets n Sales of stocks n Decrease in debtors n New capital introduced n Loans received n Increase in creditors Cash Out  n Losses n Purchase of fixed assets n Purchases of stock n Increase in debtors n Drawings or dividends n Loans repaid n Decrease in creditors

BM Unit 2 - LO36 Financial Information Trading Profit and Loss Account Balance Sheet Cashflow Statement (past year) Cash Budget/Cash Flow Forecast

BM Unit 2 - LO37 Financial Statements - Trading and Profit & Loss Account The Trading Account n Gross Profit = Sales (Turnover) - Cost of Sales The Profit & Loss Account n Net Profit = Gross Profit + Gains - Expenses

BM Unit 2 - LO38 Trading Account Trading Account for years 1 and 2 Year 1 Year 2 £000£000£000£000 Sales (- returns IN) Less Cost of Sales Opening Stock10 5 Add purchases (- returns OUT, +carriage IN) Less Closing Stock 5 10 COST OF GOODS SOLD GROSS PROFIT£60 £70

BM Unit 2 - LO39 Profit & Loss Account Trading and Profit and Loss Account for years 1 and 2 Year 1Year 2 £000£000£000£000 GROSS PROFIT£60 £70 Less Expenses Wages1620 Carriage OUT 4 5 General Expenses1620 Advertising NET PROFIT £10 £7 ==== ===

BM Unit 2 - LO310 Financial Statements - The Balance Sheet Shows: n Assets - things owned eg vehicles n Liabilities - things owed eg creditors n Equity - capital and reserves eg shares  a statement of assets (things owned) and liabilities (what is owed by a company) and how they are financed at a particular date.

BM Unit 2 - LO311 BALANCE SHEET FIXED ASSETS - premises, equipment CURRENT ASSETS - cash, stock, debtors WORKING CAPITAL: current assets - current liabilities (Net current assets) CAPITAL EMPLOYED: Fixed assets + net current assets (Net assets) CURRENT LIABILITIES eg loans, creditors Issued Share Capital: Money from shares Reserve from P&L Ac Retained profits – after dividends and CL paid. Long-term Liabilities Long term loan – debenture, mortgage

BM Unit 2 - LO312 BALANCE SHEET Balance Sheet for: year 1 and 2 Year 1Year 2 £000£000£000£000 Fixed Assets Premises Current Assets Stock80100 less Current Liabilities Creditors20 60 Working Capital60 40 Net Assets Financed by: Capital Long Term Liabilities

BM Unit 2 - LO313 Interpretation of the Final Accounts and Balance Sheet T,P&L Account: n Compare GP/NP to previous year and rival company n Look at sales figures n Efficient use of stock? Balance Sheet n Enough working capital? n Use of trade credit?

BM Unit 2 - LO314 Interpretation of the Final Accounts and Balance Sheet Interested Parties: n Management n Employees n Rival companies n Investors n Lenders n Banks

BM Unit 2 - LO315 Ratio Analysis  analysis of the final account using different accounting ratios Purposes of Interpretation n Profitability - Is the organisation earning more than it is spending? n Liquidity - Does the organisation have enough money to pay its bills? n Efficiency - Is the organisation making the best use of its resources?

BM Unit 2 - LO316 Ratio Analysis Uses n To compare current year’s performance with previous year n To compare performance with rivals n To interpret in order to improve future performance n To forecast/budget Limitations n The information is historical - too late to do anything about it n Comparisons are difficult - different conditions apply in different years and no 2 companies are the same

BM Unit 2 - LO317 Profitability Ratios Gross Profit % / GP Margin = Gross Profit x 100 Sales 1 Net Profit % / NP Margin = Net Profit x 100 Sales 1 Profit Mark-up = Gross Profit x 100 Cost of Sales 1

BM Unit 2 - LO318 Profitability Ratios Gross Profit Percentage - How much profit is made from trading Gross Profit x 100 Sales Yr 1 = 60% Yr 2 = 45% - Dropped from 60p GP from every £1 sale to 45p! Solution ? Increase price or cut costs (purchases?) Net Profit Percentage - How much overall profit (after expenses) Net Profit x 100 Sales Yr 1 = 38% Yr 2 = 36% - Dropped by 2p in every £1 sale Solution? Reduce expenses

BM Unit 2 - LO319 Profitability Ratios Profit Markup - Amount added to cost to work out selling price Gross Profit x 100 Cost of Goods Sold Yr 1 = 40% Yr 2 = 38% - cut cost of production Solution - increase selling price

BM Unit 2 - LO320 Efficiency Ratio Return on Capital Employed (ROCE) = Net Profit (before interest and tax) x 100 Capital Employed (at start) 1 ü the return business gains by using the capital invested ü Has the capital been used effectively? ü Could the capital (from investors) be used better elsewhere?

BM Unit 2 - LO321 Liquidity Ratios Current Ratio =Current Assets : Current Liabilities eg 2:1 Acid-test Ratio =(Current Assets - Stock) : Current Liabilities (NB should be >1 : 1 - if not, inability to pay debts)

BM Unit 2 - LO322 Liquidity Ratios Acid Test (Quick) Ratio CA – Stock : CL eg 1.5:1 - Does the business have enough liquid assets to cover CL? - Depends on stock usage eg Asda could have 1:1 Current Ratio CA : CL eg 2:1 - Does the business have enough current assets to pay CL in full? - Should be better than 1:1

BM Unit 2 - LO323 SUMMARY OF RATIOS n PROFITABILITY - gross profit margin/%, net profit margin/%, profit mark up EFFICIENCY – Return on Capital Employed n LIQUIDITY - Current ratio, acid test (quick) ratio

BM Unit 2 - LO324 Budgets  Statement of future expectations Purpose n monitor and control - can compare actual figures with budget figures and seek answers from those responsible n To gain information - are we doing well n To set targets - keeping within limits of spending n To delegate management authority - employees are given “freedom” within a set budget

BM Unit 2 - LO325 Cash Budgets n Cash Flow Forecast n Estimated figures n Can show when there will be a shortage or surplus of cash n Can allow for decisions to be made in advance to solve potential problems  eg overdraft OR investment

BM Unit 2 - LO326 Cash Budgets n To monitor and control individual departments or the organisation as a whole n To assess the validity of a business project in order to secure finance eg bank loan n To assess the feasibility of a business start- up or business expansion n To provide a tool for measuring progress by comparing actual figures with budgeted ones

BM Unit 2 - LO327 Cash Budgets and the Role of Management Plan - overdraft Organise - resources Command – issue budget Co-ordinate – same goals Control – measure performance Delegates - tasks Motivate - empowerment

BM Unit 2 - LO328 Using Financial Information n Reviewing past performance and assessing results n Planning future developments based on past performance n Comparing and contrasting with previous years’ and competitors’ performances

BM Unit 2 - LO329 Users of Financial Information Managers – n evaluate past and make future decisions n Predict and maintain cash flow n Control assets and liabilities n Control employees Employees – profits have been used in pay negotiations Economists – For research (assists policy-making)

BM Unit 2 - LO330 Users of Financial Information Trade Unions – FI used to negotiate pay & conditions Investors & potential investors – Predict future returns on capital Creditors – Ability to repay + assess other debts Govt & Govt bodies – Must be provided with info (BY law) eg tax General Public – Interest in eg environmental issues