Section 3 Finance An entrepreneur comes up with a new business idea They plan it well and do some market research Now they need to raise the money to set up the business Buy equipment, buy stock, have money for the first few weeks before customer’s start paying Raising finance for a new business is not easy

By the end of this section you will Finance By the end of this section you will Understand why finance is important to a new business Understand the main sources of finance and financial advice to small businesses Understand basic financial terms Understand how to calculate profit and loss Understand what cash flow is and how cash flow forecasts are interpreted Understand solutions to cash flow problems

A corner shop If you were starting a business similar to the one in the picture, what would you need to buy before you could start trading? Answers might include: a lease on the shop that is the right to rent it for an agreed period fridges and freezers to keep food fresh a till to record takings and a safe to keep money in stock to sell in the shop, e.g. food and tobacco possibly a delivery van

Sources of Finance Nilesh the decorator started his painting and decorating business with an old cheap van and now it has broken down and is not worth repairing To buy one he needs £5000 which will take him a long time to raise He has £1000 from the last 2 year’s profits His father has offered to lend him another £2000 Suggest two other sources of finance for the remaining £2000

Sources of Finance All businesses need finance at different stages in their life This is simply a source of extra money for the business Sources of finance are used for a whole range of reasons from getting the business through hard times and good times when the business wants to expand A new business will need money to set up before they start trading They need money to Buy equipment To rent or buy a building Advertise Buy stock or the inputs that are used to make the stock

Sources of Finance Bank Loan What is a bank loan? Finance provided by the bank that will be paid back over a set period of time Advantages – large amounts can be borrowed and payments can be spread over time (it doesn’t all have to be paid back in one go) Disadvantages – interest has to be paid increasing costs and repayment terms have to be met What does the bank need to give a loan? Cash flow forecast Business plan

Branch of the Cooperative bank Banks often think that new businesses are risky (that is likely to fail) and may be unwilling to lend them money. Why do banks consider many new businesses to be risky? Answers might include: because the business does not have established customers entrepreneurs may not have a lot of experience or knowledge of the industry new businesses can be short of money and therefore cannot survive difficult times competitors may respond to their entry into the market by cutting prices or increasing advertising

Sources of Finance Loan from friends and family What is this? Finance provided by family and friends where the interest rate and repayment period are agreed with them Advantages – they may be flexible about when the money has to be repaid and might not charge interest Disadvantages – they may not be able to lend very much What will they need to give a loan? trust Maybe the Business plan

Borrowing money from friends and family Why might an entrepreneur be worried about borrowing a large sum of money from a family member to start a new business? Answers might include: The family may demand repayment at short notice if they find themselves short of money. Families may argue and this can lead to demand for immediate repayment. Friends and family may not have enough money to give a large enough loan. An entrepreneur may be concerned that if the business fails he or she may not be able to repay friends and family. If a bank is not prepared to lend money (and the entrepreneur has to borrow from friends/family) it may be that the business idea is not a good one.

Sources of Finance Overdraft What is this? A flexible agreement with the bank to spend more than you have in the bank account as an when it is required Advantages – once it is set up the business can use it whenever needed without permission as long as it doesn’t go over the limit Disadvantages – high interest is paid and the bank can remove the overdraft whenever they want What will they need to give a loan? To set it up they will need to see cash flow forecasts This may be needed each year to review

Sources of Finance Mortgage What is this? Long term loan for purchasing a building Advantages – often has a fixed rate of interest and payments are monthly Disadvantages – sometimes have variable interest rates which means your costs can go up and down – it will be expensive when rates rise. Also the lender may ask for security What will they need to give a loan? The legal deeds of the property

Sources of Finance Trade credit What is this? Suppliers who allow debts for goods and services to be paid one or two months after delivery Advantages – no interest is paid – this is free finance for the period of the trade credit Disadvantages – the buyer will probably not get discounts What will they need to give a loan? References from the bank/other suppliers Maybe cash flow forecast

Sources of Finance Grants What is this? Money given to a business by a government organisation or charity Advantages – the money does not have to be paid back Disadvantages – many businesses do not qualify for them What will they need to give a loan? Many forms have to be filled out to prove the business is eligible for the grant

Northeast firms to get boost Almost £2 million of finance from the European Union has been given to the Institute of Digital Innovation (IDI) to help start 90 new companies in the northeast of England. Further finance has been given by the UK government and the University of Teesside in Middlesborough. The IDI project aims to help: entrepreneurs to start high technology businesses university graduates make a business out of their ideas The IDI not only provides finance but also offers expert advice to those planning to start up a new business. Question Why might university graduates find it difficult to raise finance to start a new business? Answers might include: ● they are likely to have little or no experience of starting and managing businesses ● they may not have much of their own money to invest into a new business ● they will not have a history of having repaid other loans successfully

When to use the different sources of Finance To decide which is the best source of finance we need to ask the following questions What is the money for? How much? How quickly will it have to be paid back? If a business only needs finance for a short period of time they should consider a short term solution such as an overdraft or trade credit If a business needs finance over a long period of time and it is a large amount then they should go for a bank loan or a mortgage E.g. An overdraft should not be used for buying equipment

Financial support and advice New businesses can get lots of free advice on the best types of finance High street banks will give free advice through their business banking service to new business owners Regional development agencies (RDA) in the UK help businesses apply for grants and put them in contact with other businesses Charitable organisations such as the Prince’s trust focuses on helping 18-30 unemployed people set up their own business. Business experts give advice and may provide a mentor for the early days. They also offer low interest loans and grants. For homework (and for discussion next time) have a look at the Business Link web site and make a note of what they do and why they are good for a small business www.businesslink.gov.uk

Quick Quiz Look at table A on P52 Try to quickly learn each type of finance Get your neighbour to test you I will then call out the information in the box and you have to guess which source of finance it is associated with Update database

Financial support and advice New businesses can get lots of free advice on the best types of finance High street banks will give free advice through their business banking service to new business owners Regional development agencies (RDA) in the UK help businesses apply for grants and put them in contact with other businesses Charitable organisations such as the Prince’s trust focuses on helping 18-30 unemployed people set up their own business. Business experts give advice and may provide a mentor for the early days. They also offer low interest loans and grants. For homework (and for discussion next time) have a look at the Business Link web site and make a note of what they do and why they are good for a small business www.businesslink.gov.uk

Assessment of section 3.1 Mark your work and let me know the mark for the database To be handed in next lesson - Monday 10th Give Ali the exam paper Photocopy Marketing Q papers

Financial terms and basic financial calculations Two big worries for an entrepreneur Am I making a loss or profit? Do I have enough cash to pay my suppliers, workers and bills? This section will help you understand the main financial terms and help you do some financial calculations

Revenue is the same as Turnover Calculating Revenue What is revenue? The amount of money a business receives from selling goods or services Revenue = number sold x selling price If I sell 10,000 hotdogs in one year and each hotdog costs £2.50 how much revenue have I taken? £25,000 To increase the revenue what could the hot dog stand owner do? Increase the selling price and hope that the amount sold does not go down Increase the amount sold by promotion Revenue is the same as Turnover What is the difference between sales and revenue? Sales is how many the business sells; Revenue is how much money the business takes for selling those items

A fruit stall Why might the owner of a fruit stall decide to reduce prices towards the end of the day? Answers might include: the owner may not want to take any of the stock away at the end of the day the stock is perishable and will be worthless in a day or two he or she may need cash to pay suppliers

Calculating Costs What is costs? The expenses a business pays in producing goods and services Rent, wages, stock, equipment, fuel etc – all of these together add up to the firm’s TOTAL COSTS The hotdog stand would have to pay what costs? Rental of the stand Ingredients (buns, sausages, ketchup etc) Wages of person on the stand Equipment used to cook the hotdogs Petrol used to get to the site Electricity etc etc Start up costs are the things that have to be bought when the business starts Running costs or operating costs are costs that the business has to pay day-to-day

A small hotel What start-up costs might an entrepreneur have to pay if she took over the hotel in the picture? Answers might include: the purchase of the building refurbishing and decorating costs purchasing new equipment such as cookers, computers and tills the costs of researching the market costs of recruiting new staff

Fusion Systems Carl Bradley runs a computer shop called Fusion Systems with his wife in Eastbourne, East Sussex. He employs three people and the business has an annual revenue of £540,000. In December 2008 Carl said that his business’s sales had fallen and therefore the business was receiving less revenue. Carl is hoping to see his costs fall, especially his fixed costs. Question What will have happened to Fusion Systems’s profits in December 2008? What might Carl do in response? Answers might include: The business’s profits are likely to have fallen unless its costs fell too. It may be that the business made a loss depending on the balance between total costs and revenue. Carl could reduce costs as he suggests; perhaps not employ so many staff or buy less stock. Carl could try to increase sales again by, for example, advertising more. Carl should really try to find out why the business’s sales fell.

Internet success Holly Tucker and Sophie Cornish are managing the rapid growth of Notonthehighstreet.com, the business they set up 2 years ago. Last year the business’s revenue was approximately £800,000 and the partners expect it to rise to £3.5 million this year. Holly and Sophie are not satisfied, however, and are planning to expand their business. Notonthehighstreet sources good-quality clothes and gifts from small producers and sells them online. Holly says, ‘We provide an opportunity for thousands of independent suppliers to sell their products. Sites like ours are acting as a kind of shop window for the long tail of the internet.’ Would you expect the business’s profits to be higher than last year? Explain your answer. Answers might include: The partners expect their business’s revenue to rise to £3.5 million this year so profits should be higher. It depends what happens to the business’s costs. They may spend money expanding the business and this could reduce next year’s profits.

Calculating Profit (or Loss) Profit = Revenue - Costs Work out these examples Vivien’s nail bar has sales revenue of £40,000 per year and total cost of £33,000 What profit does she make? 40,000 – 33,000 = £7000 Jo’s sales revenue from his pet shop is £35000 per year and his costs are £39,000. What profit does he make? 35000 – 39000 = -4000 He has made a loss of £4000 Complete activity 1 and 2 on P55

Several key terms will appear They will disappear after 30 seconds (do not write anything in this time) Your task: (1)List the terms + (2) Define them (8 mins to get as many as possible)

Loans from family and friends Overdrafts Bank Loan Mortgage revenue Profit Businesslink Grants Trade Credit Sales costs Princes Trust Loans from family and friends Owners Funds

Over to you!

Calculating Profit (or Loss) In pairs think of a business (anything at all!) and then make up a question for the rest of the class to answer Start with a plain profit or loss Then have a percentage change in price and sales Don’t forget to work out the answers Keep it simple! To find a percentage increase e.g. 10% Multiply the number by 10/100 then add that to the original Or easier Multiply by 1.1 (that’s 110%) To find a percentage decrease e.g. 20% Multiply the number by 20/100 then subtract that from the original Or easier Multiply by 0.8 (that’s 100 – 20% = 80%) 15 mins to complete

Add in pupil example Get Beth and Tamara to move

Question 1. Clever cupcakes sell an average ready-made cupcake for BD1.500. This year, we have sold 12,000 cupcakes. Calculate our revenue.

12,000 x 1.5 = BD18,000

Costs Our total cost is BD3500 and we now know that our revenue is 18,000. What would our profit/loss be?

18,000 – 3,500= Profit: BD14, 500

Question 2. After a year of success, we decide to increase the price by 10 %, however, the number of sales drop by 2%. Calculate the new revenue after one year.

11,760 x 1.650 = BD19,404

If the costs stay the same, calculate what our new profit/loss is after this new revenue

19,404 – 3,500= Profit: BD15,904

By Zaina and Lubna

Create a poster to revise Sources of finance How to calculate profit (plus all the terms)

Calculating profit - Recap All Calculating profit - Recap What is revenue? What is the formula for revenue Price x Quantity sold What is the difference between revenue and sales? Sales is how many items you sell; revenue is how much you get from selling them What is the formula for profit? Revenue – total costs = profit How can you increase profits? Increase revenue by selling more (promotion maybe) Decrease costs by being more efficient

3.2 Assessment 30 minutes to complete these short questions

Cash Flow and Survival If a business is to survive it must have cash It needs cash to be able to pay For stock Its workers The bills Think of a business like a car – it may be in perfect working condition but if it has no fuel then it won’t work. Cash is like the fuel in a car – without cash a business can’t buy stock, it can’t pay the workers – it just won’t work.

Cash Flow and Survival Cash comes in from The entrepreneur putting money into the business from his savings or a loan Sales paid for in cash Payments from customers who have been given extra time to pay rather than paying straight away (credit sales) Cash goes out When the business pays workers, suppliers or bills

Cash Flow and Survival Cash and Profit are not the same When we work out profit we use revenue less costs. The revenue figure includes goods that have been sold for credit (where the business has not yet received payment) On paper the business is making lots of revenue but if its sales are credit sales it will not have cash until the customer pays at the end of the month Cash is the money that the business has in the bank or in the till If the business runs out of cash it will not be able to operate It won’t be able to pay its suppliers so won’t get goods to sell It won’t be able to pay its workers so they won’t want to work any more

Cash Flow and Survival The business will come insolvent (it won’t be able to pay its debts) If the suppliers don’t get paid they may take the company to court The business will be put into receivership The receivers will work out what money is left in the business by selling assets and then decide which suppliers should get it The business will be closed down

Delivery van Buying a van can cause a major cash outflow for a business. Why might a new business choose to lease (rent) a van? A leased van would only result in a small payment each month — this would reduce and delay cash outflows. Any faults would be repaired by the business that owned the van — this would avoid any further large outflows of cash.

House builders Why might house builders experience a large time gap between cash outflows and cash inflows? Answers might include: Houses can take a long time to build — sometimes more than a year, so builders have to wait a long time for payment. It can take some time to sell houses, so again this means that house builders have to wait to receive inflows of cash.

Cash flow The table shows that in 2007 10% of small businesses thought that cash flow was the biggest obstacle to success. This includes small businesses that have just started up as well as those that have been trading for many years. Which of the first five obstacles does an entrepreneur have some control over? ● The business only has control (to some extent) over its cash flow. No other factors are within its control.

Cash Flow Forecasts Cash is so important that most business owners will forecast the amount they will likely to receive and spend Forecast = the business attempts to estimate future sales, cash flow or other financial variables. Cash flow forecast = a prediction of a business’s future cash inflows and outflows showing the closing balance shown in a table

Cash Flow Forecasts Complete activities 1, 2 and 3 on Page 57 We need to understand all the different parts of a cash flow forecast Receipts/Income – is all the money/cash the business receives each month – these are inflows Payments/expenditure – is all the money/cash the business pays out each month – these are outflows Net cash flow is just the difference between these two Net cash flow = Receipts – Payments Opening balance is the amount of cash the business has at the beginning of the month Closing balance is the amount of cash the business has at the end of the month Closing balance = net cash flow + opening balance Complete activities 1, 2 and 3 on Page 57

Why a Cash Flow Forecast is important Do I have enough cash to pay my suppliers? Why a Cash Flow Forecast is important It allows the business owner to check they will have enough cash available over the next few months to keep the business going . If they don’t then they can organise an overdraft or tell the bank that they need to increase their overdraft The business owner can see if he needs to reduce outflows of cash – maybe ask suppliers for more credit – to avoid running out of cash The forecast will help the owner with his application for an overdraft so that the bank can see that it will be paid back. The numbers can be used as a target for the business – it can be used to see if the business is meeting its aims. Will I need to use my overdraft? Do I have enough cash to pay my staff?

Small restaurant Why might this business run short of cash? Answers might include: it may not persuade enough customers to eat there to provide sufficient inflows of cash another restaurant may open up nearby the business’s rent may suddenly be increased by a large amount there may be a health scare about the restaurant meaning that people do not want to eat there

Using Cash Flow Forecasts When we look at a cash flow forecast we need to look at the main elements Cash in – hopefully this will be increasing in the future as the business gets more customers Cash out – the payments out should increase at the same rate as the sales – the more you make the more you have to pay for materials Closing balance – you would want to see this improving as the business grows - it is not unusual for it to be negative when the business first starts when lots of payments have to be made for equipment etc

This is the cash flow statement for Peter and Sue’s restaurant after its first month of trading in December. Do you think Peter and Sue would be pleased with the information given in this cash flow statement? A forecast is what you think is going to happen; a statement is what has happened

Yes, they would be pleased This is the first month of trading when not many people would know about the restaurant and cash inflows and cash outflows are roughly equal They have a positive balance (£980) of cash in their bank account Sue and Peter can be confident that they will have enough cash next month — unless things change dramatically Complete activity 1 and 2 P58 P59

Identifying solutions to cash flow problems There are a few solutions to cash flow problems Make payments to your suppliers at a later date – ask them for credit. However the supplier may not want to do this particularly as you are a start up business and have not earned his trust yet. Encourage receipts to be paid earlier – maybe you can encourage your customers to pay cash rather than credit with discounts however this will affect your profits. Use a source of finance such as an overdraft particularly is the cash flow issue is only a short term problem – maybe you want to buy more stock for Christmas Reduce payments out by reducing numbers of workers however this may mean more work for the owner The solution to the problem will depend on the size of the problem and whether it is caused by increasing payments or falling receipts.

Identifying solutions to cash flow problems Remember when you are answering an exam question and suggesting solutions to cash flow problems you need to think about the disadvantages too. E.g. advertising might increase sales which would increase cash in but it also costs money so it will affect cash out. In the short term it could make the cash flow problem worse. Complete activities 3, 4, 5 and 6 Complete case study on P60 Complete Revision Questions

3.3/4 Assessment

Several key terms will appear They will disappear after 30 seconds (do not write anything in this time) Your task: (1)List the terms + (2) Define them (8 mins to get as many as possible)

Mortgage costs Overdrafts Trade Credit Princes Trust Grants Profit Bank Loan Overdrafts Mortgage revenue Grants Closing balance Insolvency Cash Flow statement costs Princes Trust Cash flow forecast Profit Trade Credit

Over to you!

To do today Mark your cash flow work (if you haven’t already) Finish your finance posters (include cash flow) Revise for a finance test next lesson 

End of Finance Assessment

Cash Flow Forecast terms What are these Receipts/Income? all the money/cash the business receives each month – these are inflows Payments/expenditure? all the money/cash the business pays out each month – these are outflows Net cash flow? just the difference between these two Net cash flow = Receipts – Payments Opening balance? The amount of cash the business has at the beginning of the month Closing balance? the amount of cash the business has at the end of the month Closing balance = net cash flow + opening balance

Several key terms will appear They will disappear after 30 seconds (do not write anything in this time) Your task: (1)List the terms + (2) Define them (8 mins to get as many as possible)

Mortgage costs Overdrafts Trade Credit Princes Trust Grants Profit Bank Loan Overdrafts Mortgage revenue Grants Closing balance Insolvency Cash Flow statement costs Princes Trust Cash flow forecast Profit Trade Credit

Over to you!

Talkabout ‘Entrepreneur’ Pick a name out of the hat – that person leaves the class room Class thinks of 10 things that person should mention in their 60 seconds of talkabout Whilst the speaker talks the class listens for terms and makes a note of the ones that were mentioned Rate that person out of 10 (the number of terms achieved)

Bingo Draw the shape below and in each space write one of these terms (so you will have five in total) Enterprise, entrepreneur, opportunity cost, government grant, franchise, copyright, trademark, patent, I will read out the definition and when I have read out all of your definitions you need to call out Bingo To be able to win you need to repeat back the definitions! Before we start show the person next to you what you have chosen so that no changes can be made!!

Jeopardy For each of these answers give me the question the quaternary sector the primary and the secondary sectors The tertiary sector Selling price – costs of inputs Added value Factors of production Products or services To differentiate themselves from the competition and charge higher prices Advertising, product features, branding, location and personal service Because more value can be added in this sector

Jeopardy For each of these answers give me the question the quaternary sector – what sector transforms information? the primary and the secondary sectors – which sectors have declined over the last couple of decades in the UK? The tertiary sector – what sector does the service industry belong? Selling price – costs of inputs - how do we work out added value? Added value – what is the value of the process of transforming inputs into outputs Factors of production – what is another name for inputs? Products or services – what is another name for outputs? To differentiate themselves from the competition and charge higher prices – why would a business want to add value? Advertising, product features, branding, location and personal service – what ways can a business add value? Because more value can be added in this sector – why is there growth in the tertiary sector?

Close the loop – Business Plan You will be given 2 or 3 cards which each have one part of a sentence. The person who has (start) on their card reads out their card first. Everyone looks at their cards to see if they have the next part of the sentence and then calls that out…and so on until we reach the person with (end) on the card. See how quick we can do it!

I see you are psychic too! Yes I see that…. advertising helps increase demand demand has a negative relationship with price demand can be elastic if there are close substitutes