Unit 2

Finance for Business

LA1Understand the Cost Involved in Business

Running a business involves Cost

All businesses even the smallest business in the local village have various cost.

1.They will need to buy stock items for the shop2.Pay the shop rent3.Pay business rates for the property4.Pay bills (electric, gas, phone, broadband, TV licence etc.)

Study the diagram and in your own words define start-up costs and running costs

Different Types of Costs

1. Start up Costs

2. Running (Operating) Costs

3. Fixed Cost

4. Variable Cost

What are Start-up costs and Running Costs?

Costs are the money paid out by businesses for items that are needed

Start up Costs 1.The amount of money spent setting up a business before it starts trading (sell their product or service) is called Start up Costs 2.Businesses will use saving and loans to pay for these

Running (Operating) Costs 1.These are the money spent on regular basis to keep a business running2.These costs usually occur on daily basis.

Fixed Cost(or OVERHEADS)

Fixed Cost (or Indirect Cost)- •These are the money spent (expenditure) on items which does not change with the number of items sold or produced

•These have to be paid no matter how much products the business makes or sells or how many costumers it has.

•Can you think of some examples?

Variable Cost

1. Variable Cost (or Direct Cost)- The cost are directly related/ or vary according to the amount of items sold or produced

2. Can you think of any examples?

What is a Start Up Capital

• The total amount of money required to start up a new business is known as START UP CAPITAL

What is Income

Is all forms/sorts of money which is paid into a business

Total Cost

• The total amount of money spent running a business over a certain period of time is called the TOTAL COST

• E.G– A month– 6 months– A year– 10 years

Calculating Total Cost

Total Cost = Fixed Cost + Variable Cost

Task 11. Explain the following terms in your own

words:a. Start up Costs b. Running (Operating) Costs c. Fixed Costd. Variable Cost

2. List as many start up and running costs that you think a business may have

3. What is the difference between Consumable Products and Raw Materials

Task 2

Activity - Sarah’s Cakes – Sarah wants to set up a business making celebration cakes. She wants to convert her garage into a commercial kitchen.

1.Give 2 examples of start up costs for Sarah

2.Give 2 examples of running costs

LA2 Understand how Businesses Make

Profit?

Revenue and Profit

Generating Revenue (INCOME) through:1. Selling their products and services

•If the revenue they generate is more than the cost of making or obtaining the items and running the business, then the owners make PROFIT•After paying TAX on the INCOME the owner can chose what to do with their profit

Sources of Income for Businesses

Through:1.What customers pay for products and services

2.Interest paid on money in bank savings accounts

3.Investment income from people buying shares in the business or lending it money (a bank loan, for example)

4.Leasing or Rental income by renting out equipment or property that is not currently required or in use to other businesses

5.Charities rely on PUBLIC donations

6.Sate institutions (like schools) are funded by the government

Revenue CalculationREVENUE=

Number of sales x Price per Unit

Task 31. Outline and explain all the different

means through which a business can generate revenue

2. What will be the total revenue raised by selling 2,000 items priced £30?

3. What will be the total revenue raised by selling 5 apples at 50p each, 11 bananas at £1.00 each and 22 chocolate bars at 1.88p each in a local corner shop

LA3 Understanding Expenditure In

Business

Money that a business SPENDS

What do Business spend money on?

Businesses spend money to succeed1.They pay bills2.Rent and business rates3.They buy stock to sell4.Telecommunication links and website maintenance5.Pay for raw materials to make products6.Vehicles and fuel7.Printing cost8.Spend money on adverts or promotions9.Consumable items10.Pay wages/salaries

Understanding Profit

Profit= means that your revenue is more than your

expenditure

Loss= means that your expenditure is more than your

revenue

Profit/Loss= Revenue - Expenditure

Task 4Write down the answers to the following questions

1.Which of the following items is a source of revenue to a hairdresser?a. Advertising b. selling shampoo and conditioning products staff wagesc. Electricity bill

2.Yaw’s expenditure in in his first 3 months of trading was £10000 and his revenue 12517. use the correct formula to calculate his profit/loss3.Sam runs a small business selling Jewellery online. He estimates that he will sell 200 items next month which will cost him an average of £20 each. He thinks that his overheads will amount to £2000. Copy the table and complete it to calculate his total costs for the month

4.Jack has 2 bills to pay. The 1st is for 80 small jewellery boxes. The 2nd is for his internet connection. Which of these is a variable cost and which is a fixed cost

Variables 200x……………=

Fixed cost

Total cost

LA4 Planning Tools for Profit Prediction

BreakevenIncome

Expenditure

BreakevenLoss Profit

Breakeven Calculation

Break-even point=

Fixed Cost---------------------------------------------

Selling price per unit - Variable cost per Unit

Tom is considering starting a mobile hot dog van business. He reckons his fixed cost would average £100 per week and variable cost for each hot dog would be 80P. He aims to sell theHotdogs for £1.30 and wants to find out how many he would need to sell in a week before he would start to make profit.

£100------------------£1.30 - 80P

=200 Hot DogsBreak-even point =

Task 5

Calculate the Breakeven point for this scenario

•If a product sells for £5, the variable cost is £3 and the fixed cost is £300, what is the breakeven point?

•Use the formula to calculate

Task 6-Billy’s Bears

• Billy makes teddy bears in his factory• His FIXED COSTS are £2,100, • His VARIABLE COSTS are £5 per bear and his

SELLING PRICE is £10 per bear• How many bears does he need to make to break

even?

Structure of a Breakeven GraphCosts &

Revenues

Output/Sales

0500100 200 300 400

5000

4000

3000

2000

1000

The Breakeven point is where the TC and TR lines meet

Costs & Revenues

Output/Sales

0 500100 200 300 400

5000

4000

3000

2000

1000

Total revenue

Total Costs

Fixed Costs

B/Even Graph for Billy’s Bears

Costs & Revenues

Output/Sales

0 500100 200 300 400

5000

4000

3000

2000

1000

Total revenue

Total Costs

Fixed Costs

Area of Loss

Area of Profit

B.E.P

Billy’s Bear Factory Ltd.Output/Sales Fixed Costs Variable

CostsTotal Costs(FC+VC)

Total Revenues(Price x Output)

0 2100 0 2100 0

105 2100

210 2100

315 2100

420 2100

Changes in Sales or Cost on Breakeven Points

• If sale or cost change, the breakeven points will also change

• If you have to pay more for your cost price, your selling price will have to change else you will earn less money which means you will have to sell more to break even

• In retail the difference between the buying and selling price is called the MARGIN

• The higher the margin the more potential profit

Effects of changes on breakeven points

• Increase in sales -the MARGINE of safety increases

• Decrease in sales- the MARGINE of safety decreases, if sales fall below the break-even level, the business could make a loss

• Increase in cost- the number of sales required to break even increases so the profit level will fall or even lead to a loss

• Decrease in cost- breakeven point is lower so the business makes more profit

Task 7

What will be the effects of these changes on breakeven points

Type of change Effect on break-even point

Increase in sales

Decrease in sales

Increase in cost

Decrease in cost

LA5Understand the tools businesses

use to plan for success

Budgeting (tool 1)

The purpose of budgetingIt helps people and business to get what they want by

planningIt is a process of setting targets for SPENDING and

REVENUE over a future period of time

•They are used for things such as :1.Forecasting start up cost for a new business2.Introducing a new product3.Forecasting sales revenue

The MAIN purpose of a budget is to ensure that a business is in control of its revenue and expenditure

so that it makes profit

The person in charge of

monitoring a budget is called = The Budget

Holder

The purpose of budgeting• Budgetary control- this is the process of checking what is

actually happening with the budget, comparing this with your plans and taking the necessary actions if things are not correct

• It can be achieved by:

1. Measuring actual performance regularly- at least once a month

2. Giving this information to the budget holder who checks for any differences between the planed targets and actual

performance (if expenditure has been too high or sales targets not met, the budget holder will take steps to correct this)

Task 81. What is a budget?

2. What is the main reason why business tend to have a budget?

3. Who is a Budget Holder?

4. What do you understand by the term Budgetary Control

5. How can an excellent Budgetary Control be achieved in a business setting?

LA5Understand the tools

businesses use to plan for success

Cash Flow-(Tool 2)

What is the purpose of cash flow?

• Cash Flow: is the amount of money entering a business’s bank account

• The purpose of cash flow forecast (also know as cash

budget) is to identify the money that should be coming into the business(inflow) and the money going out of the business(outflow) over a period of time

• Cash flow forecast= Positive/Negative bank balance has an effect on a business why?

Net Flow and Cash BalanceNet cash flow:

The difference between the cash inflow and the cash outflow figures of a business over a period of time

Cash balance (opening/closing):The amount of money forecast to be in the bank account or in the possession of a business after the net cash flow figure has been added or subtracted from the existing bank balance

Task 9

The following table is muddled up. Redraw it and write the following inflows and out flows in the correct columns

inflows Out flows

Cash sales Capital investment

Advertising Bank interest received

Sale of premises Salaries

Heat and lighting Purchases

Loan from the bank Utility bills

Staff wages Interest on loans

Materials for manufacturing

rentals

insurance Rent received

Calculating net cash flow

Net cash flow = Total Inflow- Total Outflow

Closing Cash balance in bank

= Opening bank balance + Net cash flow

Task 10Anna runs a small florist business. On 1 June she decides to carry out a cash flow forecast for the month ahead. She does some calculations and notes these figures down:

1.Cash inflow: £24002.Cash outflow: £21003.Opening bank balance: £1200

1.What would be Anna’s Net cash flow? (show how you arrive at your answer)

2.What would be her Closing Cash balance in bank? show how you arrive at your answer)

3.Study Anna's calculations and work out what would happen if the outflow figure was £2600 and all of the other figures remained the same

Task 111. Give 2 purposes of cash flows for a business

2. State 2 inflows for a business and explain why they are inflows

3. State 2 outflows for a business and explain why they are outflows

4. Where does the opening balance of a cash flow come from?

5. Why will the closing balance for one month be the same as the opening balance for the next month?

Cash flow Timings & forecast to plan for success

The actual time when money enters and leaves a business’s bank accounts can be critical. e.g. if a large payment from a customer is overdue, the bank balance could be negative and overdraft charges would apply. Click here to see some of the effects of this on some businesses

Benefits of a cash flow forecast:Click here for more information

Task 12

1. Draw a bubble diagram to show the benefits of a cash flow forecast. Try to think of at least 4 benefits

2. Explain how a cash flow forecast can be used to determine the impact of the timing of investment in new resources

Task 131. Create this table and complete the cash flow forecast for Ben who

runs a pet ambulance service. He discovered that his van is in need of repair and will be off the road for 2 weeks in July.

2. How do you think Ben will react to this information?3. What will you advice him to do?

Ben’s cash flow forecast

June (£) July (£) August (£)

Total receipts (inflows) 1000 400 1200

Total payments (outflows) 500 1200 1500

Net cash flow

Opening balance 200

Closing balance

Task 14

Draw up your own cash flow statement using the following information:

Jan £ Feb £ Mar £

Sales 19,500 18,580 26,400

Sale of van 3000

purchases 13,400 10,000 16000

1. There is no opening balance

2. Wages are £5000 each month

3. A machine will be bought in Feb for £5500

4. There will be an electricity bill in March expected to cost £3560

Understanding Cash Flow forecast• Cash flow forecast is completed by entering:

1. Outflows of the month (period)

2. Inflows of the month (period)

3. Calculating the net cash flow

4. Working out what the closing balance will at the end of the month (This will be the opening balance of the next forecast)

5. The most important figure in the cash flow forecast is the CLOSING BALANCE

6. Small positive balance= business can pay it bills and a danger of going bankrupt

7. Large positive balance= there is money available for investment

8. Small negative balance= money may have to be borrowed to least for a short while

9. Large negative balance= business can not pay its way and may go bankrupt

Task 151. What 2 important figures are shown in a cash flow forecast?

2. What 2 things can cause a problem with the net flow/ outflow figures?

3. Give 2 ways you could increase receipts

4. Give 2 ways you could reduce cost

5. What do we mean by a deficit and why it is a problem?

6. Apart from increasing receipts and decreasing cost, give 2 other ways of dealing with a deficit

7. Why can surplus be seen as a problem?

LA6HOW Do BUSINESSES MEASURE SUCCESS?

Some Key Term• The 2 main documents that helps manager to assess the success

of their business are:1. The Income statement (aka Profit and Loss account)- contains all

the income and expenditure of the business2. The Statement of financial position (aka the balance sheet)-

shows how the money invested (CAPITAL) in the business has been spent

• COST OF SALES- the cost of producing a product

• GROSS PROFIT- the money made from selling a product(aka the Sales Revenue) after the cost of producing that product(aka Cost of Sales) has been taken from it

• NET PROFIT- the money made from selling a product after all COST (expenditure) has been taken from the Gross Profit

Cost of Sales the cost of producing a product

What does it involves:1. Cost of materials2. Cost of direct labour3. Other direct expenses (e.g. VAT)I am making tables. The wood for 1 table cost £4 (this is my row

material). I have to pay a carpenter £6 to turn the wood into a table(his wages are called direct labour). Let assume there is no VAT to pay

The cost of producing 1 table is:Direct Cost=£4 + Direct labour =£10If I sell 10 tables, they cost me £100 (10£x 10) so I will say my cost of

sales for 10 tables = £100

Task 16

• Explain these KEY TERMs in your own words:1.Income statement 2.Statement of financial position3.Capital4.Cost of sales5.Gross profit6.Net profit

Task 171. I am making handbags. I use £3 worth of leather in each bag

and pay a machinist £2 for each bag he sewsI. What is the cost of producing one bag?II. What is my cost of sale if I produce and sell 15 handbags?

2. I am making wedding cakes. To make one cake I use £1 of flour and eggs, £2 of fruit,£1.50 in icing sugar and I put a little statue on top which cost £5.50. I pay the cook £10 per hour and it takes her half an hour to maker the cake.I. What is the cost of producing 1 cake?II. What is my cost of sale if I produce and sell 5 cakes

3. Draw up a list of materials you would use if you were:I. Hair dresserII. BuilderIII. A hot-dog vendor

formula

• Gross Profit = Revenue – Cost of Sales

• Net profit = Gross profit – Expenditure

• Cost of Sale= Direct Cost+ Direct labour

Profit/Loss StatementWhen I sold a car I could work out my net profit as follows:

£ £ Notice how the figures are kept in neat columns using the pound sign as guidesREVENUE 2000

- Cost of sale 1200

= Gross profit 800

EXPENDITURE Notice how the individual amounts of expenditure are listed in the first column, then totalled in the second

Repainting 500

MOT 100

Advert 100

Total Expenditure

700 This makes it easier to work out the Net Profit

Net Profit 100

Task 18

• A business has sales of £25,000 which cost £12500. It had to pay rent of £1000, insurance of £500 and a sales man’s wages at £1000. Draw up a profit statement like the one above.

Task 19

• Mr O’Brain had £16500 sales this year with cost of sales as £2510. He now tells you that he had the following expenditure during the year:

1. Wages=£47502. Adverts=£5253. Heating and light=£1430

1.Draw up his profit statement and show his net profit

Task 20• Jim owns a hot dog van. His sales are £19,250 for the

bread and rolls he sold and paid a cook £3500 to make the hotdogs in the van

• He also had the following expenditure during the year:

1. Van tax and insurance=£5502. Petrol=£4003. Adverts=£880

1.Work out his:1. Cost of sales2. Gross profit3. Total expenditure4. Net profit

Impact of positive and negative profit figures

All business want to have a positive profit figure because a negative profit mounts to a loss

Gross Profit and its Impact Net Profit and its Impact

It GP is positive, this means that revenue is greater than the cost of sales

If the NP is positive it means that the GP is also positive and expenditure is within budgeted levels

Action to take id GP is low or negative:

1.Increase sales revenue(e.g. increase sales volumes or prices)

2.Reduce cost of sales(e.g. using cheaper raw materials, bulk buying, changing suppliers or negotiating better discounts)

If NP is low it may be because GP is too low and/or expenses are too high. Action to take:1.Increase GP

2.Reduce expenses by checking overheads (fixed Costs) to see where savings can be made

Task 21

• What are the impacts of positive and negative profit figures on both:

1.Gross profit2.Net Profit

FINANCIAL STATEMENTS

Financial statements are documents that sums up the financial activities of a business and provides an immediate

indication of its financial position. These statements are very important because it helps us to know what we OWE OUT and what is OWED TO US at any point in time

People who are interested in a financial statement

1. Shareholders2. Managers3. Employees4. Suppliers5. Customers6. The government(HMRC)7. competitors

?

People who are interested in a financial statement

1. Shareholders-is the money they invest safe? Will a good dividend be paid?

2. Managers-is the business being managed well? Is it expanding or contracting?

3. Employees- are their jobs safe? Can a wage rise be afforded?

4. Suppliers- has the business enough money to pay what it owes?

5. Customers- can the business meet orders?

6. The government(HMRC)- How much corporation tax is owed

7. Competitors- are we making more or less profit than our competitors?

Task 22

• How can a financial statement be beneficial to the following people:

1. Shareholders2. Managers3. Employees4. Suppliers5. Customers6. The government(HMRC)7. competitors

Task 231. What is the definition of a financial

statement?

2. What is the primary purpose of a financial statement?

3. How can an income statement(profit and loss account) be used to measure success?

4. How can a statement of financial position(balance sheet) be used to measure success?

Statement of Financial Position

(Balance sheet)))

Statement of financial position (Balance sheet)

Assets (+)Liabilities (-)

Statement of financial position (Balance sheet)

Assets (+)

Liabilities (-)

Important Terms1. Financial year: the trading period over which

a business collects information for their annual income statement

2. Debtors/trade receivables: people who owe money to the business for goods or services they have received

3. Creditors/Trade payables: traders to whom the business owe money because they have supplied the business with goods/services

4. Liability: amounts of money which a business owes

5. Share Capital: the amount of money invested into a business by shareholders

That does a balance sheet show?Assets(Fixed or current)

1. All the things the business owns2. The money it has in the bank3. Money the business is owed by other people ( debtors or trade

receivables)

FIXED ASSETS

Items the business must keep to enable it to trade such as van, computers, building- they are called fixed because there are here to stay

CURRENT ASSETS

Item that keep on changing with every transaction such as stock, debtors, cash in the bank.

Liabilities

All the money the business owes to other people or businesses e.g. suppliers and banks

Current liabilities

Money that has to be paid back with a year such as suppliers and bank overdraft

Long term Liabilities

Includes loans that can be repaid over a long period

Capital The capital that is put into the business. This may include:1.Money Invested by the shareholders or the owner of the business2.Retained Profits from previous years

Task 24That do you understand by the following terminologies in relation to a balance sheet:

1.Financial year2.Debtors/trade receivables3.Creditor/trade payables:4.Liabilities:5.Share Capital:6.Assets7.Fixed assets8.Current assets9.Current liabilities10.Long term liabilities

Example 1

On 1 Jan Densil started up a business with £5000 in the bank

Balance sheet for Densil at 1 Jan

Assets £ Liabilities £

• Bank 5000 • Capital 5000

5000 5000

We put 1 line under a list of figures and add them up

We put 2 lines under the total figure

Example 2

On 2 Jan Densil bought a van by cheque for £2000

If you pay by cheque, your bank balance goes down. Densil has £5000 in the bank, he now has £ 3000 after that payment, also Densil now owns something else- He

owns a van ( an asset worth £2000)

Balance sheet for Densil at 2 Jan

Assets £ Liabilities £

Bank • 3000 • Capital 5000

van • 2000

5000 5000

Example 3

On 3 Jan Densil bought some stock for £500 from a supplier called K Little. He will pay later in the month

Now he has another asset called “stock” which is worth £500, he has not yet paid for it so the bank balance will not change. However, what has changed is that he

now “owes” money (liability) to K little

Balance sheet for Densil at 3 Jan

Assets £ Liabilities £

• Bank 3000 • Capital 5000

• van 2000 • creditor 500

• stock 500

5500 5500

Task 25

• Draw a new balance sheet for Densil for the 4 Jan by considering this information.On the 4th of Jan Densil sells £200 of the stock to D Brown. Mr. Brown will

pay him later in the month.

Task 26

• On the 5th of Jan Mr. Brown pays Densil the £200 he owes him in cash

Draw a new balance sheet for Densil for the 5 Jan by considering the

information above

Task 271. What is the another name for a balance sheet?

2. What is the purpose of this document

3. What is the difference between an asset and a liability?

4. What is capital?

5. What is a creditor?

6. What is another name for a creditor?

7. What is a debtor?

8. What is another name for a debtor

Task 28Draw up a list od assets and a list of liabilities using the

following:•Bank•Debtors•Capital•Cash•Van•Premises•Creditors•Machinery•Stock•Loan