Management of
Finance
Business Management
National 5
Contents
The role of the finance function....................................................................................................... 3
2.1 ................................... Describing sources of finance and outline their costs and benefits
......................................................................................................................................................... 4
Short-term sources of finance ..................................................................................................... 4
Medium-term sources of finance ................................................................................................ 4
Long-term sources of finance ..................................................................................................... 5
Sources of Finance – Cost & Benefits ........................................................................................ 6
Financial help from the government ........................................................................................... 7
2.2 Interpreting a break even chart ............................................................................................. 8
2.3 .......... Interpreting a cash budget to identify cash flow issues and outlining appropriate
solutions......................................................................................................................................... 9
PAYMENTS ................................................................................................................................. 10
Cash flow problems .................................................................................................................... 11
Methods of improving cash flow ............................................................................................... 12
2.4 ...................................... Preparing a simple profit and loss statement from data provided
....................................................................................................................................................... 13
Trading and Profit and Loss Account....................................................................................... 13
Gross Profit.................................................................................................................................... 13
The Profit and Loss Account ..................................................................................................... 14
Net Profit ...................................................................................................................................... 14
The Profit and Loss Account shows how profitable a business has been over a
period of time. .................................................................................................................... 14
Role of technology in managing finance ................................................................................. 15
Glossary of terms ........................................................................................................................ 16
2
The role of the finance function
Finance is important to every organisation, because all organisations have to d eal with
money. However, different types of organisations have different financial objectives.
Companies in the private sector like Kwik-Fit have financial objectives to do with
maximising profit. Public sector organisations, will want to be as efficien t with their
finances as possible, so that communities benefit. Businesses in the third sector, for
example charities or clubs may have the different financial objective. A charity may
have an objective of getting as many donations as possible. They may also aim to use
their funds as effectively as they can so that they can help as many people as
possible. Clubs may wish to use the funds they have to improve the facilities they
offer to their members.
All these different types of organisations share the need to have good financial
management. Every organisation must manage its finances efficiently to ensure the
success of its business – whatever this is. For example, every organisation must make
sure that it:
 has enough money to pay the wages and salaries of its employees
 has enough money to pay its bills – for things like supplies of raw materials,
electricity, advertising and so on
 has enough money to develop new products to avoid being overtaken by competitors
 checks how much it is spending – organisations, which have high costs, are often
unsuccessful.
The finance department is responsible for the financial affairs of the organisation. Its
role is to manage the finances of the organisation and to make sure that the
organisation meets its financial objectives. It has three main tasks:



Payment of wages and salaries
Payment of accounts
Maintenance of financial records and accounts
3
2.1
Describing sources of finance and outline their costs and benefits
The most important source of finance for firms is internal in the form of
retained profits – that is, profits which, rather than being issued to
shareholders or taken as drawings by the owner/s, are put back into the
business to generate more profits in future.
External sources of finance may be short-, medium- or long-term.
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.youtube.c
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Short-term sources of finance
 Bank overdraft – for short-term borrowing, that is to enable a firm to continue
trading over a brief period when its needs for cash will exceed the money it has
available, banks provide overdrafts. An overdraft is an agreement by the bank that
the firm may draw from its current account up to a certain amount more than it has
in the account – the ‘overdraft limit’.
 Debt factoring – this involves the firm selling its debts to a ‘factor’ for less than
their face value. The factor collects the full amount from the debtor and his profit is
the difference between the two.
 Trade credit – negotiating a longer period between receiving goods from suppliers
and having to pay for them (or a shorter period between sending goods to customers
and receiving payment from them).
NB All the above are only temporary methods which may enable a firm to keep trading
for a while – if the firm is not profitable extensive use of short -term solutions will
ultimately lead to greater losses.
Medium-term sources of finance
 Bank loans are the most common way in which businesses can get funds for the
medium term, which usually means about 2–4 years. Medium-term sources of
finance are normally required to acquire machinery or other equipment which will
need to be replaced at the end of the period.
 Hire purchase is often used to obtain equipment or vehicles when the firm does not
have the full amount in cash.
4
Long-term sources of finance
 Mortgages are a long-term method of borrowing – for example, in order to buy
premises. Interest is added to the loan at the beginning and the whole amount is
usually repaid in equal monthly instalments over a period of years.
 Debentures – limited companies can borrow money by selling debentures, which
are long-term ‘IOUs’.
 ‘Sale and leaseback’ agreements – these involve the firm selling assets such as
machinery to a finance company and then leasing (that is, renting) them back from
the company. Alternatively firms may lease rather than buy technology from the
start, thus freeing the funds, which would have been tied up in its purchase, for
other uses.
 Capital – for example, by the sole trader or partners adding more of their own
money to the business, or by a company issuing more shares – as long as its issued
capital (the value of shares actually sold to shareholders) is less than its authorised
capital (the maximum value of shares the firm could issue according to its
Memorandum of Association).
 Venture capital – this finance is available to firms whose projects may be too risky
to secure a bank loan, but are judged viable by the specialist organisations offering
this help, such as 3i (Investors in Industry).
Think of a local business and
write down which sources of
finance they would use, and
what they would use them for.
5
Sources of Finance – Cost & Benefits
Source of Finance
Bank Overdraft
Costs
Interest is charged only on the amount overdrawn and any
cash paid in to the account reduces the amount of the
overdraft.
Benefits
Many firms have a permanent overdraft facility to tide
them over difficult times such as the end of the month
when staff must be paid before income from sales has
been received.
Debt Factoring
The firm will not receive 100% of the money owed to them by
customers.
This can enable small firms to avoid cash flow
problems.
Trade Credit
The firm may have to pay their suppliers before the firm’s customers
pay them therefore may create a negative cash flow.
Can provide a firm with more cash to use in the
short term.
Bank Loans
Banks normally charge a higher rate of interest on loans than
they do on overdrafts because they see them as more risky.
Businesses pay back the loan in agreed instalments,
e.g. every month during the period of the loan.
Hire Purchase
The items are owned by the hire purchase company until the last
instalment is paid.
The cost plus interest is paid in equal instalments
over a set period of time.
Mortgages
The rate of interest charged will depend on the length of the
mortgage and the collateral (security) offered. The longer the
loan and the higher the collateral, the lower the interes t rate.
Mortgages are often used by businesses which cannot
issues shares or debentures, e.g. sole traders.
Debentures
Debenture holders receive interest annually and the firm must
repay the loan at the end of the specified period of time.
For companies a useful way of raising necessary longtem finance.
Sale & Leaseback
The business does not own its equipment.
Frees up cash for other business activities.
Capital
Once the capital has been invested there may be no more available
from the same source.
May charge a higher rate of interest on any money loaned due to
risk.
Tend to be one off payments
It’s the cash from the owner therefore does not need to
be paid back.
When the firm is taking a risk this is an important source
of finance to investigate.
Provides finance which does not have to be repaid
Venture Capital
Government Grant
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Financial help from the government
 The government’s Loan Guarantee Scheme enables small and
medium-sized firms to get loans which the banks would otherwise
consider too risky. The government agrees to repay 70% of the loan
should the borrower default. In return the borrowing firm has to pay a
higher rate of interest than the market rate, and an insurance premium.
 Government grants – the government may help a business by giving it
money for a specific purpose (e.g. to firms setting up in rural areas or
where there is high unemployment). A grant does not have to be paid
back.
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2.2 Interpreting a break even chart
The break even point is the point at which total sales revenue (income) and total costs
are equal.
At this point the business is not making either a profit or a loss. Any sales above the break
even point mean the business will make a profit.
This can be clearly shown on a diagram.
Variable costs are the bills and expenses that the business has to pay that change according
to output. The more the business produces the more the variable costs are going to be.
Variable costs are the costs of materials for production, cost of labour, etc.
Fixed costs are the bills or expenses that the business has to pay that do not change with
output eg factory rent, insurance, council rates etc.
Total costs are fixed costs plus variable costs.
Have a go at Fixed or Variable in the costs
section or any of the Break even analysis
activities.
http://www.businessstudiesonline.co.uk/GcseBusi
ness/Activities/Module5/Module5Menu.htm#GCS
EBusMod5Costs
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2.3 Interpreting a cash budget to identify cash flow issues and outlining
appropriate solutions
In every organisation money comes in and goes out. Businesses have to decide how
they can manage receipts and payments so that there is always enough cash to pay
the bills of the business or to buy assets for the business. Organisations may also
need to know whether they will have to borrow money to make payments.
A cash budget:






shows, usually on a monthly basis, how much cash t he organisation has available
shows what money came in during the period
shows what money went out during the period
alerts the business to any cash flow problems
is used to help make decisions
can be used to forecast whether a loan or overdraft may be nec essary.
A cash budget calculates the amount of money the firm has available at the end of
each month. It begins with the opening balance. This is the amount available to the
business at the start of the month. The next step is to add the receipts for t he month
to the opening balance. Payments made by the firm are then taken away. This gives
the closing balance. This is the amount of money left at the end of the month.
The following example explains and illustrates a cash budget. The information is f or
Les King, a sole trader. It applies to his first three months of trading.
Before we can do a cash budget, we need some background information about Les’s
business. Les started up his business with £500 savings and he estimates his
receipts for the next three months to be as follows:
June
July
August
Start up grant
Cash Sales
Cash Sales
£1,500
£1,600
£1,400
His monthly payments are as follows:
Rent
£30
0
Telephone £40
Advertising
£10
0
Electricity
£10
0
Wages
£25
0
He also has to buy stock as follows:
June
£800
July
£700
August
£700
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The figures have been used to produce the cash budget below for Les’s first three
months of trading. To find out whether the business has enough money to continue,
the following calculation is made:
The opening balance is the amount of money in the bank or in cash in the business at
the start of the month.
This is added to the total receipts – the money that has been received into the
business – for example, from selling goods. This gives the total cash availa ble for that
month.
Then, the total payments – any amounts that have been paid out of the business – are
taken away from the total cash available.
This gives the closing balance – the amount of money left in the business at the end
of the months trading.
The closing balance at the end of one month is the opening balance for the next
month.
Cash Budget for Les King – June–August
Opening Balance
Add RECEIPTS
Grant
Sales
June
£500
July
£410
August
£520
£2,000
£1,600
£2,010
£1,400
£1,920
£300
£40
£100
£100
£250
£800
£300
£40
£100
£100
£250
£700
£300
£40
£100
£100
£250
£700
£1,590
£1,490
£1,490
£410
£520
£430
£1,500
PAYMENTS
Rent
Telephone
Advertising
Electricity
Wages
Purchases of stock for
resale
Closing Balance
In June, Les had £500 available in the bank at the start of the month. He also received
a total of £1,500 during the month, as he received a grant. This meant he had a total
of £2,000 available to spend on the business. During the month he spent a total of
£1,590 on rent, telephone, advertising, electricity, wages and stock. This left him with
a total of £410 at the end of the month. This, therefore, was the opening balance he
had available at the start of July.
Les can use the cash budget to find out if the business will have enough money to do
what he plans. He can find out from it whether he will have to look for additional forms
of finance to help him continue in business.
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Decisions that Les takes in the business can affect his ability to pay his bills. For
instance, suppose Les decides in August that he wants to buy a computer for the
business. The total cost will be £2,000. By examining his cash budget we can see
that he only has £430 left. Les has not got enough cash to buy the computer.
Therefore, to ensure his business does not get into cash flow problems, he could
consider:

leasing the computer – this would mean that he
would pay monthly amounts to a leasing company
to use the computer. However, he would not own
the computer and at the end of the leasing period,
it would have to be returned to the leasing
company.

getting a loan for the computer – Les could get
the computer straight away instead of saving for it,
by applying for a loan. However, interest would have to be paid to the bank or
another lender in addition to the repayments for the loan.

buying the computer on hire purchase – again Les could get the computer
straight away, but usually he would have to pay interest along with the monthly
repayments.
A cash budget can therefore be used to help the decision making process in
businesses. It shows whether there is enough money for the business to do what it
plans. It can also show whether a business needs to find cash from somewhere else.
It can help business answer questions such as:


Do I need to arrange an overdraft/loan?
Do I have enough money to buy a new piece of
equipment?
Cash flow problems
Cash flow problems can arise even if the firm is successful in selling a lot of its goods.
If goods are being sold on credit, customers do not pay for them straight away. This
can lead to cash flow problems, as the company is having to pay for their stock and
overheads like heat, light, petrol, rent and wages before their customers are paying for
the goods.
It is therefore vital that cash flow is well controlled to make sure a business is
successful. The following points should be noted:
 Timing of flows of cash into and out of a firm is crucial. This is as important as the
total amount of cash generated.
 Companies don’t go bankrupt because they lose money, they go bankrupt because
they run out of money.
 Companies that make sure that they always have enough cash available for their
needs are more likely to be
Have a go at the Cash Flow Forecasts on
successful.
this link:
http://www.businessstudiesonline.co.uk/GcseBu
siness/Activities/Module5/Module5Menu.htm#
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GCSEBusMod5Costs
Methods of improving cash flow
There are many ways in which organisations can
improve their cash flow. Some of these include:
 raising extra capital by re-investing profits,
issuing shares, or by the owner investing more funds. By doing this, the
organisation will get an inflow of cash.
 taking out loans – from a bank or other financial institution. Small organisations
can get a loan from friends or partners. By doing this, the organisation will get an
inflow of cash but repayments (including interest) will have to be made regularly.
 tight credit control – this means that the firm should ensure that it collects the
money owed by debtors (people who owe the firm money) as quickly as possible.
This will improve the inflow of money but may cause bad feelings with customers
who may leave and go to other suppliers.
 sale and lease back – selling fixed assets to a leasing company to raise money and
then leasing them back. This will provide an inflow of cash but there will be regular
payments to the leasing company.
 spreading purchase costs – hire purchase or leasing. This will mean that the
outflow of cash will not be in one month but will be spread over a number of months.
 tight stock control – ensuring capital is not tied up in too much stock. This will
help to keep the outflow of cash to a reasonable level.
 checking customers’ credit worthiness before goods are sent out – this will
ensure that customers are reliable and will pay their bills. This, in turn, means that
the inflow of cash is kept up.
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2.4
Preparing a simple profit and loss statement from data provided
Final accounts
Financial records must be kept to:



keep a secure record of all transactions to prevent fraud
produce accounts for tax purposes
monitor business performance so that managers and owners can see how well th e
firm is doing.
Businesses prepare final accounts to provide a financial summary of all trading
activities during the year. The Final Accounts are called a Trading, Profit and Loss
Account and a Balance Sheet.
Trading and Profit and Loss Account
This can be split up into the Trading Account and the Profit and Loss Account. The
Trading Account shows the gross profit (or loss) for a business. The gross profit is
the sales revenue minus the costs of the goods. So, the trading account shows how
much money has been spent on buying stock and how much money was made when
the stock was sold. In other words, the trading account shows the profit, before
charging any expenses or overheads like heat, light, wages or telephone bills.
An example of a Trading Account is shown below.
D Bloom’s Trading Account for year ending 31 December
£
Sales
-Cost of Goods Sold
Opening Stock
Add Purchases
Less Closing Stock
Cost of Goods Sold
GROSS PROFIT
£
3,000
1,000
2,150
_____
3,150
1,950
____
1,200
_____
£1,800
_____
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The opening stock is the stock left over from last year, which can be sold this year.
The opening stock is added to any purchases of stock this year. This gives the stock
the business has available to sell during the year. The closing stock is any stock left
at the end of the year. This is taken away from the stock available to give the cost of
the goods, which the business has sold during the year. This cost of goods sold is
then taken away from the sales revenue (i.e. the money made from selling the goods
to customers). This gives the gross profit made during the year. Businesses don’t
always make profits so this could be a gross loss in some cases.
The Profit and Loss Account
The Profit and Loss Account is completed after the
Trading Account. It shows the net profit. It includes
all expenses and overheads like heating, lighting,
wages, telephone bills, etc.
Net profit is gross profit minus all expenses and overheads. The Profit and Loss
Account shows how expenses affect the final or net profit that the business makes
during the year.
The Profit and Loss Account starts with the gross profit. Any additional income (or
revenue) that the business has got is added to this. This additional revenue could
come from things like discounts or from selling items that the business owns.
Then the expenses involved in running the business are deducted. This gives the net
profit (or loss).
An example of a Profit and Loss Account is shown below:
D Bloom Profit and Loss Account for year ending 31
December
£
Gross Profit
£
1,800
Less Expenses
Telephone
Rent
Wages
Electricity
NET PROFIT
100
150
175
200
625
£1,375
The Profit and Loss Account shows how profitable a business has been over a
period of time.
Have a go at the Sweet Treats
Trading, Profit and Loss Activity.
14
Role of technology in managing finance

Use of spreadsheets to reduce calculating errors.

Use of templates so that information is understood by all employees.

Accounting software, so that information can be processed quickly.

What if scenarios, to help managers make decisions.

Tracking of figures on a daily/weekly/monthly basis.

Use of email to send information to the correct people.

Use of intranet to communicate relevant figures with staff.

Use of spreadsheets to produce charts making figures more easily understood.

Using powepoints to communicate financial information.
Paired Task
Write down a list of 7 software applications Greggs
would use. Describe a task that the finance
department would use each software application for.
15
Glossary of terms
Term
Meaning
break even
is the point at which total sales revenue (income) and total costs are
equal. At this point the business is not making either a profit or a
loss.
creditors
people from whom we buy goods on credit and whom we have
not yet paid, or others owed money e.g. bank. Creditors are
shown in the Balance Sheet as a current liability.
debtors
customers to whom we have sold goods on credit and who
have not yet paid. Shown in the Balance Sheet as a current
asset.
expenses
these have to be paid in the running of the business – e.g.
rent, wages, and electricity bills.
fixed costs
do not change with output eg factory rent, insurance, council rates
etc.
gross profit
(loss)
difference between cost of goods sold and sales revenue.
hire purchase
spreading the payments of a purchase over a period of time.
income
money the business receives in the form of sales revenue.
net profit
(loss)
if expenses are less than gross profit a net profit will occur. If
expenses are greater than the gross profit, then a net loss will
occur.
overheads
expenses of a business other than materials or labour.
profit and loss
account
after gross profit has been calculated any additional gains are
added to gross profit and then expenses are deducted to find a
net profit or net loss.
total costs
fixed costs plus variable costs.
trading
account
this statement is prepared to calculate the cost of goods sold
and the gross profit. If the sales figure is greater than the cost
of goods sold then the firm has made a gross profit. If sales
figure is less than the cost of goods sold then the firm has
made a gross loss.
variable costs
these costs change with the output level eg raw materials.
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