Theme 2: Managing

Business activities
Managing business activities:
THEME 2 - MANAGING BUSINESS ACTIVITIES:

FINANCE: the funding required to set up and expand a business.

Internal sources of finance:

Internal finance refers to the funds that come from within the business itself, not from an
external source.
●​ 3 sources of internal finance

1.​ Owners Capital

Where the money that the person that is aiming to set up the business may have
saved or otherwise come by (redundancy payment / inheritance)

Advantages:
1.​ No debt is accumulated when the owner's capital is used as a source of
finance, as the money has not been borrowed.
2.​ Flexible source of finance - the entrepreneur can use the finance in whatever
way he or she desires. I.e it doesn’t have to be used for a specific purpose.
​ ​
​ Disadvantages:
1.​ May not be sufficient finance to meet all the business’ needs. The
entrepreneur may need to acquire additional sources of finance to fully fund
the business.
2.​ If a owner sets up a sole tradership or a partnership, he/she will have
unlimited liability. If the business fails, owners’ capital can be lost + personal
assets.

2. Retained Profit
Where profit is kept in a business rather than being paid out to the owners (i.e the
entrepreneur if the business is a sole trader OR shareholders if the business is a
company.)
 Advantages:
1.​ Low cost source of finance as no debt is accumulated when retained profit is
used. This implies no interest has to be paid, which would be the case if a
loan had been used instead.
2.​ Flexible source of finance - retained profit can be used for any purpose the
entrepreneur wants to use it for. In reality, ploughing retained profit back into
the business is a common way of growing a business.

3.​ Sale of Assets

The sale of items of property owned by a person or a company, regarded as
having value eg: selling off an item of equipment in exchange for cash.

Advantages:
1.​ Cash raised through selling off items owned by the business which
can then be used for a whole variety of purposes.
2.​ Selling assets can reduce business costs as, once sold, the asset no
longer needs to be maintained.
3.​ Can be used as part of a ‘Rationalisation’ strategy (The removal of
space capacity in a business). Not only is cash raised by selling off
assets but the business can also become more efficient by removing
unused machinery and equipment.
4.​ Sale and Leaseback is an option (An asset is sold in exchange for cash
and if then leased back from a leasing company) ← In this way, the
business retains use of the asset but NOT the ownership of the asset.

​ ​ Disadvantages
1.​ May raise an inadequate amount of cash if the asset is of low value.
In this case, the business would need to access additional finance
sources (NB: The asset is also second hand)
2.​ Problems if demand increases in the future. If assets have been sold
off, the business may not be able to accommodate any future increase
in demand.
3.​ If sale and leaseback is used a monthly leasing fee is payable to the
leasing company to secure ongoing access to the asset.

External Sources of Finance:

External finance is money raised from outside the business, such as loans, investments, or
crowdfunding, rather than from the owner’s personal savings.

Finance that comes from outside a business.

1.​ Family and Friends:

Advantages:
1.​ Family and friends may offer low cost / no cost loans (possibly with a
generous repayment term).
Disadvantage:
1.​ If repayments are not made, it can cause relationship problems within
the family / with friends.
2.​ May not be able to secure enough finance, only to rely on family and
friends.

2.​ Banks:
Defn: Financial institutions that provide fixed term loans in return for
repayment of the amount borrowed and a monthly interest payment.

3.​ Peer-to-peer funding (funding circle):

Defn: A finance source that involves lending without going through a bank or
other financial institution.
Advantages:
1.​ Useful if the loan request has been turned down by the bank.
2.​ Interest rates charged by peer to peer lenders may be lower than
when borrowing from a bank.

Disadvantage:
1.​ Brand new businesses may find it difficult to secure finance from a
peer to peer lender. ( May need to be an established business to
secure peer to peer finance.
2.​ Using peer to peer finance means that the business accumulates debt
that must be repaid each month with interest. This can put a strain on
the business’ cash flow.

4.​ Business Angel:

Defn: These are wealthy entrepreneurial individuals who provide capital in
exchange for a share of the business
NB: Business angels do not lend the business money. They are investors into
the business and hence part owners of the business.
Eg: Dragon’s Den

5.​ Crowdfunding:
 Crowdfunding is a method of raising capital by collecting small contributions
from a large number of people, typically via online platforms, to support a
new business idea or project.

EG: Crowdfuner

Advantages:

1.​ As each investor is only putting a small sum of money into the business
people may be more prepared to provide finance.
2.​ The business can decide what it wants to give in return for the finance
provided to them.

Disadvantage:
1.​ Brand new businesses may find it difficult to secure finance from a
peer to peer lender. ( May need to be an established business to
secure peer to peer finance.
2.​ Using peer to peer finance means that the business accumulates debt
that must be repaid each month with interest. This can put a strain on
the business’ cash flow.

-​ Success at raising finance is partially dependent on the business’ ability to market its
idea to the general public.

-​ If the business fails to raise the desired sum of finance, it can damage the business’
image and reputation

Other businesses
Defn: Other businesses - This is where a business approaches another business to raise finance.
Often, the business that is approached for finance will seek an ownership stake in the business that
requires finance in return for money. This has the same issues as with business angels.

Methods of Finance:

Loan
Defn: Loan -
A form of debt finance, where a sum of money is borrowed from a bank or other lender for an
agreed period of time with regular monthly repayments and interest added.

Advantages
1.​ A lender is a creditor to the business rather than an owner of the business. This
avoids dilution of control.
Defn: Creditor - a person or organisation that lends a business money.

2.​ When a business gains a new shareholder, it means that the business has just
gained another owner. By borrowing money from a bank, no new owner has been
acquired by the business. This means that the business has not had to give up any
ownership and control to secure the loan.
Defn: Dilution of control - giving up some control over the business by gaining
another owner through selling shares

3.​ Repayments of a loan are often fixed, month by month. This means that the business
knows exactly how much money it must repay to the bank month by month in order
to fully repay the loans. This helps the business manage its cash flow.

4.​ It can be quicker to agree a loan than to organise a new issue of shares. This makes
borrowing money a faster way of securing finance than a ‘share issue’.

Disadvantages
1.​ Increases the ‘risk’ level of the firm. This is because, irrespective of a business’
trading performance, the loan must be repaid every month without fail. Should the
business fail to make the monthly loan repayment, the bank has a claim on the
business’ assets.

2.​ Loans can be an expensive source of finance, because more will always be paid
back than was initially borrowed. This is because, interest wll always be added on to
the original sum borrowed. E.g. if £20,000 borrowed as a loan, £25,000 may
eventually be paid back once interest is added on.

3.​ If an unincorporated business series a loan, personal assets may be seized if the
loan is not repaid. (sole traders/partnerships - unlimited liability

●​ Share Capital:
Definition: Funds raised by issuing shares in return for cash.
 → The purchase of a share, makes the owner of the share a part-owner of the
company.

→ The more shares that are held, the greater the degree of control the shareholder
has over company decisions.

→3 motivations for holding shares:

1.​ To earn an income - shareholders are paid dividends. Dividends are paid out
of profit that are made. The more shares that are owned, the greater the
dividends that will be earnt.
Dividends = the payment a company can make to shareholders if it has made a profit

2.​ To exert control - As shareholders are part owners of the company, owning a
share, gives the shareholder some degree of control over the decisions that
are made. It is the shareholders that appoint the ‘company directors’. These
are the people who run the company on behalf of the shareholders.

3.​ To benefit from capital gains - Some investors buy shares as a speculative
investment i.e they buy the share when its cheap and sell it when the share
price rises. We call this financial return a capital gain.

Types of share:
→ 2 main types:

1.​ Equity capital / ordinary share capital

→ These are shares that pay a variable dividend (based on the value of profits
made).
→ Give the owner a vote at the AGM (Annual General Meeting).
→ last in line for payment - if the company collapses, creditors will be repaid
first. If there are funds that then remain, the ordinary shareholders will be
given back their capital last of all.

2.​ Preference Shares

→ These shares pay a fixed dividend.
→ No vote at the AGM.
→ If the company collapses, preference shareholders will get their capital
investment back before the ordinary shareholders are repaid.

Advantages of Share Capital:

 1.​ Avoid the acquisition of new creditors. The more creditors a business has, the greater
the level of risk attached to a business (as the loans must be repaid, irrespective of
the business’ performance).
NB: shareholders are not creditors to a business, they are in fact part owners.

2.​ Huge sums of capital can be raised by ‘floating’ (when a PLC releases shares for sale
on the stock market for the first time).

3.​ Dividends are payable out of profit made. This means if little profit is made, few
dividends need to be paid.

Disadvantages of Share Capital:

1.​ The issue of shares can leave the company vulnerable to takeover. If a ‘predator’
buys up the majority of a company’s shares, it can assume ownership of the
company.

2.​ Arranging a new share issue / float can be expensive. (relative to requesting a loan
from a bank)

3.​ Dilution of control:

→ The issue of shares means the ownership of the company is more diluted. The
original founders of the company have less control over the business that they had
before.

4.​ Profit must be shared (in the form of dividends) with the other shareholders.

●​ Venture capital:
Definition: This is money invested into a business in which there is a substantial
element of risk in exchange for equity in the business.

NB: Venture capital is provided by a Business Angel.

​ Advantages:
1.​ Advice and support can be given by the business angel. As these people are
highly experienced and successful entrepreneurs, this advice can be
invaluable.
2.​ Money can generally be gained quickly, as venture capitals are wealthy
people who have funds available for quick investment.
3.​ Business Angels may lend money where banks have previously refused to
provide a loan. This makes venture capital a suitable source of finance for
riskier businesses.
 Disadvantages:
1.​ The Business Angel will demand a share in the company eg: a 20% share
stake. This means that by accepting funds from a business angel, control of
the company is diluted.
2.​ Profit has to be shared with the business angel in proportion to the business
angel’s stake in the company.
3.​ Problems may arise if there are disagreements between the business angel
and the entrepreneur regarding the future direction of the company.
Overdraft:
Definition: Where a bank allows a firm to withdraw more money than the firm has in its
bank account.
→ This is one of the most common sources of finance used by most UK businesses.

Advantages:
1.​ Most commonly used to cover short term periods of illiquidity.
Illiquidity defn - A period of time where a business is short of cash.
2.​ Interest is only charged on the daily sum overdrawn.
3.​ Overdrafts are the most flexible source of finance. An overdraft facility (i.e the right
to overdraw one’s bank account) can be used or not used as desired. If it is used, a
business can be overdrawn for as long as they wish or clear the overdraft at any time
they wish.

NB:
-​ In the ‘Black’ → the business has a positive bank balance.
-​ In the ‘Red’ → the business is overdrawn

Disadvantages:

1.​ Can become an expensive form of finance if the business is persistently overdrawn.
This is because interest is charged daily on the sum overdrawn. This suggest an
ongoing interest charged until the overdraft is cleared.
2.​ The bank can ‘call in’ an overdraft at any time. As the provision of an overdraft
facility is in the gift of the bank, the bank has the right to withdraw the facility at any
time.
(NB: In normal circumstances it is unlikely that they would do this)
3.​ If the business exceeds its agreed overdraft limit eg: £2000, a penalty charge is
payable. Hence, businesses must carefully manage their finances to ensure they do
not exceed the agreed limit.
Leasing:
Definition: This is a financial facility that allows a business to use an asset for a fixed period
of time in return for regular payments eg: leasing a delivery vehicle.

Advantages:
1.​ No down payment required i.e no sum of money has to be paid upfront for the
business to gain use of the asset.
2.​ The leasing company will provide technology updates as part of the leasing
agreement. I.e as new technology advances, the leasing company will replace the
old assets with the latest technology.
3.​ Should the asset break down, the leasing company is responsible for maintaining the
asset. This will reduce maintenance costs for the business.

Disadvantages:

1.​ A business that leases assets, will need to make payments every month in order to
continue benefiting from the asset. Over the longer term, this may prove to be more
expensive than buying the asset oneself.
2.​ The business will never own the asset.
3.​ If the leasing of an asset is part of a ‘sale and leaseback’ agreement, the asset base
of the business is reduced in exchange for ongoing payments.

Trade Credit:
Definition: This is a short term source of finance, where suppliers deliver goods now, and are
willing to wait a number of days for payment.

NB: Typical trade credit periods = 30, 60 or 90 days.

Advantages:
1.​ Helps businesses manage their cash flow. This is because, businesses are given time
to liquidate (i.e sell) the stock and generate cash, before they are required to make a
payment to their suppliers.
 2.​ Can be a valuable marketing strategy for a supplier. If a business can offer generous
trade credit terms to its customers, that supplier becomes a more ‘attractive’
business to its customers. Eg: a luxury leather goods manufacturer gives Selfridges 2
months trade.
3.​ Can help ensure the survival of start-up businesses.
→ As a new business will not have developed a loyal customer base, it cannot
guarantee a regular inflow of cash into the business until the loyal customer base has
been created. This will take time. By taking trade credit form suppliers it enables the
new start-up to generate sales slowly, earn cash and only then repay the supplier.
Without this trade credit facility the new start-up may not survive.

Disadvantages:

1.​ Administration costs - businesses have to keep a careful set of records of which
supplier is due to be paid and when that repayment is to occur. This costs the
business both time and money to track repayment.
2.​ There is a danger when a business takes too much credit from its suppliers. This is
because a lot of debt may ‘come due’ at the same time. If the business has not
managed to sell all of its stock, it may not be able to repay its suppliers.
3.​ Trade credit can only be used for the supply of goods BUT businesses also use a
number of services, marketing agencies, insurance services etc. services are not
available with trade credit.

7. Grants - funds given by the government or charity to help a business get started e.g: The
Princes trust.

Advantages:
1.​ Grants do not have to be repaid.
2.​ The grant can be used as the entrepreneur wishes.
Disadvantages:
1.​ It may be difficult to access this source of furnace because there may be many
competing entrepreneurs all trying ro qualify for the grant.
2.​ The business may need to meet every strict criteria / guidelines in order to qualify
for the grant (e.g: the business may need to have some form of social objective).

BUSINESS PLANNING:
a forecast of business operations, including a statement of the business objectives, a cash
flow forecast, staffing needs, marketing methods.
1. Executive summary: this outlines the core function of the business i.e what is the
business going to offer?
●​ What element of ‘consumer pain’ (a problem that a consumer faces) has been
identified.
●​ How is the pain going to be relieved?

2. The product - USP

Two main things:
1.​ Brief description of what the product is
2.​ Identify the USP (soap grater?)

3. Marketing plan:
Marketing plan would include -
1.​ Market research
2.​ Market map
3.​ Plan for achieving the businesses marketing objectives.

4. Financial plan: includes -

1.​ A cash flow forecast (a predictions of the cash that is expected to flow into and out
of the business over the course of the year)
2.​ A projected income statement (used to be called a ‘profit and loss’ account).
●​ This outlines the predicted sales, costs and profit/loss over the next year.

5. Operational plan:
This is a section of the business plan, outlines how the product will be produced and
delivered. (i.e distribution)

Costs and benefits:

Benefits Costs

Used to secure finance: Lack of experience:

A bank / peer to peer lender / business To produce a realistic and comprehensive
angel, will typically ask to see a business business plan takes skill and experience. For
plan, before they offer to lend money / a new start-up, the entrepreneur may lack
invest in the business. For example, if a the knowledge to conduct accurate market
bank is to lend money to a business, the research / cash flow projections / sales
bank will want to know that the business is projections etc. This could make the plan of
able to pay back the loan. limited usefulness if the data is inaccurate.
NB: Inexperienced entrepreneurs typically
overstake the positives and undertake the
negatives/ risks.

Requires entrepreneur to consider the Time taken:

future: There is an opportunity cost (the benefit
There are elements of the business plan forgone by the best alternative)attached to
e.g: forecast, income statement / cash flow the hours needed to create a business plan.
forecast, that requires the entrepreneur to Those hours could have been used more
look ahead and think about what the future productively in another area of starting up
will look like. This might not happen, if no the business.
business plan was produced. The benefit of
producing a business plan is that business
owners will at least have thought about the
future and the possible challenges that may
lie ahead. This makes them better prepared
for the future.

Can be used as a motivational tool: Depends on Finance Source Required:

As a business plan contains a set of Not all finance providers require a business
objectives, and a forecast for both sales, plan before they will provide finance. Eg:
profit and cashflow, the entrepreneur can family and friends may not ask to see the
use the plan to motivate their staff to plan. If the finance source is internal, no
achieve those forecasts eg: hit a sales target business plan will be required to use this
of £1000,000 in year 1. finance.

Provides a sense of direction: External influences:

As the plan contains a detailed set of Even if the business plan has been expertly
business objectives, this can give the crafted, things can change in the external
entrepreneur a sense of direction i.e a environment that can render the business
target to aim for eg: to hit the planned plan inaccurate. For example, if a new firm
target of £25,000 profit for the year. unexpectedly enters the market, the sals
(Objectives are measurable and time and cash flow data will suddenly be
specific). inaccurate.

External influences lie outside of a business’

control and often, cannot be predicted in
advice eg: Covid lockdown.
 May reduce interest / investment stake:
A well thought out and detailed plan, can
give lenders/investors the confidence in the
business to offer a lower interest share on
loans or a smaller ‘share stake’ in the
company. This is because a well produced
plan can help creditors / investors see that
the business is a low risk investment.

Breakeven analysis = an operating position where the business neither generates a profit or
a loss.

The Importance of Cash in Business:

Rule: Cash is the lifeblood of a business. Without cash, a business cannot survive in
the short run.
→ This is because bills must be paid which implies cash is required. If bills are
not paid, the business can be forced to close. ‘Cash is King’ Tukka Suleman

The uses of cash in business:

1.​ To purchase to stock
2.​ To pay staff wages
3.​ To pay for raw materials and components.
4.​ To pay bills e.g. electricity bills.
5.​ To pay rent
6.​ Repayment of bank loans
7.​ To pay marketing expenses
8.​ To pay taxes
9.​ To pay ‘business insurance’.
10.​To pay delivery costs such as fuel.
11.​To pay business rates ( a tax paid to the council for services such as refuse
collection)
The format of a Cash Flow Forecasting:

Cash at Start of month:

On the 1st of the months how much money the business has is in its bank account
known as ‘Opening Balance’ or ‘Balance Brought forward’
​
Cash inflows:
How much cash the business expects to flow in during the course of the month.

Cash at End of the Month:

Known as ‘Closing balance’ or ‘Balance carried forward’.
​
Net cash flow = Cash inflows - cash outflows

Closing balance = opening balance + net cashflow

NB: In cashflow forecasting a negative number is shown in brackets eg: (1500) means
-£1500.

Benefits of Cash Flow Forecasting:

1.​ Identify Potential Shortfalls:
A cashflow forecast enables a business to anticipate when more cash is
flowing out of the business than flowing in. This then enables a business to
take a corrective action in advance of the shortfall actually happening.

2.​ Ensure suppliers/employees can be paid:

Employees and suppliers must be paid on time. In order to do this, the
business must ensure that it has a ready supply of cash available. By
constructing a CFF, the business can see if there are going to be months when
they will be short of cash. They can then take corrective action ahead of the
problem actually occurring.
​ → If you pay your suppliers late they will take away trade credit.

3.​ Spot Probs with customer payments:

If too much sales credit (i.e giving your customers credit - time to pay for the
goods and services they’ve received) is given, there will be a delay before cash
 is actually received by the business. A firm needs to ensure that enough cash
flows in each month to be able to pay it’s bills.

4.​ Arrange Overdraft?

Overdrafts are used to cover short term periods of illiquidity (business short
of cash). If a cash deficit (i.e a lack of cash) is identified through the Cash Flow
Forecast process, an appropriate sized overdraft can be arranged to see the
business through a period of cash shortage.

Limitations of Cash FLow Forecast:

1.​ Inaccurate Assumptions:
To produce a CFF, a business must predict cash inflows over the forthcoming
year and cash outflows. If the assumptions that underpin those assumptions
are incorrect (eg: overly optimistic sales forecasts), the CFF will not present an
accurate picture of the business’ cash position.

2.​ Unexpected Events (flooding/covid)

The business environment is an unpredictable one. Things happen that it
would be impossible to predict. For example, the business may flood
unexpectedly or there may be a fire. These uncertain events will make the
Cash flow forecast inaccurate BUT are impossible to predict in advance.

3.​ New Business Forecasting Problems?

A new entrepreneur will lack the skills to make accurate cash inflow and
outflow predictions. Typically new entrepreneurs are overly optimistic about
cash inflows, and underplay the size of the cash outflows. This then makes the
CFF of less usefulness to the entrepreneur themselves and to other lenders
(eg: banks).

Solving cash flow problems:

Speed Up/Increase cash inflows

Methods of speeding Up Cash Inflows:

1.​ Run a sales promotion (eg: buy one, get the 2nd half price) - this should
increase sales and bring in more cash BUT also raises business costs as more
stock needs to be ordered.
 2.​ Cut the price. If demand is price elastic, demand (sales) will increase, greater
than proportionally which will speed up cash inflows BUT
a)​ Requires more stock which also increases cash outflows.
b)​ Won’t work if demand is price inelastic (would need to raise the selling
price if this is the case).
3.​ Promote the product more heavily which would boost sales (cash inflows)
BUT promotion costs money so cash outflows would also increase AND the
promotional spending is not guaranteed to work.
4.​ Sale and leaseback → by selling off assets businesses can raise cash quickly.
They would then lease back the asset from a leasing company. BUT an ongoing
payment must be paid to the leasing company (i.e a monthly cash outflow)
and the business will never regain ownership of the asset.
5.​ Debt Factoring - small businesses often struggle to receive payment from
larger customers on time. To overcome this problem, a business could turn to
a debt factor to chase the debt on their behalf. For small businesses, it is often
the bank who performs the debt factoring service. An example would be: - The
debt factor pays 85% of the sum owed straight away to the small business. The
debt factor would then chase the debt from the larger firm. Once the debt was
recovered, the debt factor would give the small business another 10%, and
keep the remaining 5% for themselves as the ‘factoring fee’. BUT the small
business does not reclaim 100% of the total sum owed. In fact, the small
business only reclaims 95%.
6.​ Reduce the sales credit period → By reducing the amount of sales credit given
to customers eg: 60 days, reduced to 30 days, it should increase the speed at
which cash enters the business. BUT - generous sales credit is a valuable
marketing strategy in business. By reducing the sales credit period, the
business becomes less attractive than competing firms that offer more
generous sales credit.

Slow Down / Reduce Cash Outflows

Methods of slowing down Cash Inflows:

1.​ Defer unnecessary expenditure - for example, if a new piece of equipment

doesn’t need to be purchased today then don’t buy it today. Buy it next year
instead BUT what if competitors are investing in the latest technology right
now. In this situation, competitors may be able to attract more customers as
they’re using the latest equipment.
 2.​ Take more trade credit - This means extending the amount of time allowed to
pay for stock eg: 60 → 90 days. BUT - administrating the payments becomes
complicated as there may be a big time lag between customers settling their
debts and suppliers getting paid.
3.​ Rationalise the business - (i.e removing all spare capacity in the business ) eg:
delayed the organisation which would reduce the wage bill and lower cash
outflows. (Delaying is the removal of one or more layers of the hierarchy in an
attempt to improve operations efficiency) BUT loss of experienced decision
makers.
4.​ Find cheaper suppliers → This will reduce cash outflows BUT quality may
suffer.

Sales Forecasting
Sales Forecasting defn:
A prediction of sales revenue based on the historical number of sales made and
current market research and trends.

Purpose / benefits include:-

1.​ Staffing
A sales forecast would indicate whether sales were expected to grow or
decline in the future. As a result, firms can then establish whether they need
more staff or less staff in the future. If sales are expected to grow in the future
the business can start to arrange a recruitment and selection process.
2.​ Cash Flow Forecast and Profit Forecast
A forecast of monthly sales is required in order to produce a cash flow
forecast. Given that sales received each month feeds into an estimate of cash
inflows, a cash flow forecast cannot be produced without the creation of some
form of sales forecast. A business plan also requires an estimate of likely profit
made over the next year. Sales are one half of the profit formula i.e sales
 revenue - total costs. Hence, a profit forecast cannot be derived without a
sales forecast.
3.​ Budgeting:
Budgeting defn:
A budget is a financial plan concerning the cost and revenues of a firm.
​ For example:
-​ If a department has a cost budget ‘ expenditure budget of £ 30,000 it
means that the department is not allowed to spend more than £30,000
over the course of a year.
-​ Similarly if a sales department has a budget of £100,000 it means that
the sales department should aim to achieve at least £100,000 in sales.
A sales forecast will help a finance department establish a realistic sales
budget for the sales team.
4.​ Can be derived from Market Research Data or Past Sales Data

Factors Affecting Sales Forecasts

Once a business has spent time deriving a sales forecast, external factors (i.e things
outside a business’ control) can affect the business’ ability to achieve its forecast level
of sales.

1.​ Consumer Trends:

In dynamic markets, consumer trends change rapidly. If consumer taste moves
against ones’ company, the sales forecast will become unachievable.
2.​ Economic Variables (recession):
Changes in the economic activity are outside the control of a business. For
example if the economy moves into a recession unexpectedly.
→ Recession - 2 successive quarters of falling national income (GDP).
In recession, consumer spending falls. If a business sells a normal good
(demand falls if income falls), then its sales will fall as the economy shrinks.
This means the sales forecast will no longer be accurate.
3.​ Competitor actions:
 If ons competitors suddenly decided to cut their selling price OR promote
more heavily (for example), they would inevitably make more sales at your
expense. This means that the sales forecast made at the start of the year is no
longer accurate.

A sales trend strips out fluctuations in sales data to reveal an underlying trend. By
extending the trend line forwards into the future, an estimate of sales in the future
can be derived.

Budget = A financial plan for the future concerning the revenues and costs of a
business.

Balance sheet = a statement of what a business owns versus what it owes at a

particular moment in time.

Difficulties of forecasting sales:

1.​ New Business - No Historical Information:

Businesses will often look at past sales records as a starting point for working
out this years sales forecast. BUT - a new business has no previous sales
records to refer to. They have to begin from scratch. This makes it more likely
that a new entrepreneur will derive an inaccurate forecast.
2.​ Technological Change:
New technologies often create new markets (eg the introduction of social
media). As technology creates new sources of consumer demand (eg: the
introduction of vinted) a firm’s sales forecast is likely to become inaccurate.
(NB:- Technological change is particularly significant in dynamic markets).
3.​ Inaccurate consumer response:
Market research is the main tool used to derive a sales forecast. BUT for an
accurate set of results, businesses rely on consumers answering market
research questions honestly (eg: what price would you pay? / how often
would you visit the shop etc). If consumers are not honest when they respond
to market researchers, the sales forecast derived will not be accurate.
4.​ Changes in Market conditions (New entrants?)
If new firms unexpectedly enter the market, then any sales forecast derived at
the start of the year will no longer be accurate. It is likely that new entrants
 will steal some market share and hence the sales forecast made will not
represent reality.
5.​ Inexperienced entrepreneur:
The forecasting of sales requires some business experience and knowledge to
gain an accurate forecast. For new entrepreneurs, skills may be lacking due to
a lack of business experience, resulting in an inaccurate sales forecast.

The calculation of profit in Business:

Profit is a ‘trading surplus’ that results when all business costs are subtracted from a
business’ sales.

Sales revenue is the total value of sales generated by a firm in a given time period.

Profit Formula:

Profit = Sales revenue - Total costs

Sales Revenue Formula:

Sales revenue = Price per unit X Quantity Sold

Sales revenue = P X Q
-​ Sales revenue also known as Total revenue or Turnover

Total Costs Formula:

Total Costs = Fixed Costs + Variable Cost

Total Costs = FC + VC

-​ Fixed Costs = Costs that do not vary with output produced eg: rent, heating,
lighting, advertising.
-​ Variable Costs = a cost that varies directly with output produced eg: raw
materials or piece rate labour.

The difference between the total variable cost and variable cost per unit

→ Variable cost per unit refers to the variable cost of producing one unit of output.
→ Total variable cost (TVC) is the sum of all variable costs added together.

Total Variable Cost =

Variable cost per unit x Output produced
NB: Don't forget to include a £ sign.
Profit Questions:
1.Sales revenue = Price per unit X Quantity Sold
Sales Revenue = £7.90x 25,000=£197 500

Total Variable Cost =

Variable cost per unit x Output produced
0.50 x 25,000 = 12500

Total Costs = Fixed Costs + Variable Cost

Total Cost = 20,000 + 12500 = 32500

Profit = Sales revenue - Total costs

Profit=£197,500-32500=£165 000

2.Sales revenue = Price per unit X Quantity Sold

Sales Revenue = £32.00x5,000=£160,000

Total Variable Cost =

Variable cost per unit x Output produced
30 x 5000 = 150000
Total Costs = Fixed Costs + Variable Cost
Total Cost = £3000+£150 000 = 153 000

Profit = Sales revenue - Total costs

Profit=£160,000-£153 000=£7000

3.Sales revenue = Price per unit X Quantity Sold

Sales Revenue = £5.70x 23,000=£131,100

Total Variable Cost = 5,000

Total Costs = Fixed Costs + Variable Cost

Total Cost = 50,000 +5,000=£55000

Profit = Sales revenue - Total costs

Profit=£131,100-£5,5000=£76,100

Calculating profit via the Contribution method

This is an alternative way of calculating profit. There are 3 steps.

1.Calculate Contribution per Unit

Contribution per unit = Selling price per unit- Variable cost per unit

Contribution per unit = Selling price per unit- Variable

cost per unit

2.Calculate Total contribution

Total Contribution = Contribution per unit X Quantity Sold

Total Contribution = Contribution per unit X Quantity

Sold
Same as
Total Contribution = (Selling price per unit- Variable) X
Quantity Sold

3.Subtract Fixed Cost from total contribution

Profit= Total contribution - Fixed Costs
Profit= Total contribution - Fixed Costs

Breakeven
Breakeven:
The study of a business’ costs and revenues at all possible levels of output to
establish the dividing line between profit and loss.

NB: The Breakeven point refers to a level of output at which neither profit or loss is
made i.e
TR = TC
Or
TR - TC = £0 (Profit = £0)

The value of establishing the breakeven point

(i.e conducting breakeven analysis)

1.​ A Breakeven analysis is often required when requesting finance. A Breakeven

analysis may be required by a bank or a business angel before the lender /
investor will offer finance.

2.​ Establishes an output target for entrepreneurs as breakeven shows an

entrepreneur how much output must be produced and sold in order to avoid
losses.

3.​ A breakeven target can be used as a motivational tool for staff as the
breakeven point sets a target for production and sales staff to avoid losses.
 4.​ ‘What if’ analyses can be conducted, to assess the impact on profit of different
prices, or changing variable costs or changing fixed costs. This helps
entrepreneurs prepare for all eventualities.

5.​ Forces entrepreneurs to consider what their variable and fixed costs structures
are before starting a new business. This helps entrepreneurs prepare more
effectively for starting their businesses.

The Breakeven Chart

This is a graphical representation of the breakeven point.

TC = TVC + TFC
Total cost = Total variable cost +Total fixed costs
​
Total Costs on the Curve:
The Total cost curve starts at the minimum point of the fixed cost curve and then
rises parallel to the variable cost curve. This is because if NO output is produced, the
firm must still pay its fixed costs (eg: rent). Therefore, total cost must equal Fixed Cost
at Zero Units of Output (No variable costs are incurred at this point). As the firm
starts to produce output, variable costs will start to rise as the firm will require raw
materials. As fixed costs are constant, the rise in total cost will be equivalent to the
rise in variable cost and so we draw these on curves parallel to each other.
TC = FC + VC
Total Revenue on the Curve:
Rule: Total revenue will always be steeper than total costs.

-​ The total revenue curve shows the value of sales that would be made at
different levels of output.

-​ Breakeven occurs where Total Revenue = Total Cost

I.e no profit or loss is made

-​ Q* = the output that must be produced and sold in order for the firm to
break-even (i.e avoid losses).
Rule:
1.​ Any operating position the the Right of the breakeven level of output is a
position where the firm will make a profit i.e total revenue is greater than
total costs (eg: Q’)
2.​ If total cost is greater than total revenue (i.e to the Left of the Breakeven
point), the firm will make a loss. (Eg: Q’’)
The Margin of Safety
This calculation shows, how for output can fall before the firm starts to generate
losses.
​
Formula for Margin of Safety:
Margin of Safety = Current output level - Breakeven level of
output.
​
For example, if the firm was producing Q’ units of output, the margin of safety would
be (Q’ - Q*) units of output.
NB: MOS is expressed as a certain number of units of output eg: 15 units of output.
Calculating the breakeven level of output:

Breakeven = Fixed Costs

​ ​ ----------------- = x units of output
​ Contribution per unit

Contribution per unit (£) =

Selling price per unit - Variable cost per unit

Total Contribution = Sales Revenue - total

variable cost
Internal Factors Affecting the Break Even Chart
1)​ Extra launch advertising
If there is a rise in launch advertising expenditure, the fixed costs of the business will
increase. This will also cause the total cost curve line to move upwards. We see the
breakeven point shift from Q* to Q’, indicating that move output now needs to be
produced and sold to break even (i.e cover the higher total costs of production).

2)​ Planned Price Increase

If the firm were to increase the selling price, the TR Curve would become more steep.
This is because for every unit produced and sold, more revenue is now gained. This
means that the firms total costs can be covered more quickly, which means that the
breakeven point will move quickly, which means that the breakeven point will move
to the left, eg: £5 earned before per unit £10 earned now per unit.
1)​ Use more machinery less direct labour:
-​ Direct Labour refers to the labour costs that are directly related to the
quantity of output produced i.e piece rate labour costs.
Limitations of Break Even Analysis:
1. Might be based on Unrealistic assumptions (Constant Price?)
A break even model is based on the assumption that a firm can maintain a constant
selling price and still sell more units of output. In reality, the Total Revenue curve is
more likely to look like a bell-shaped curve.

This is because, in the real world, if a firm wishes to sell more units of output, it can’t
maintain a constant price. It has to cut the price. This means that the TR Curve shown
in a breakeven model, is not a realistic outcome for a business.
2.Assumed that sales are the same as Output

The model assumes that any output produced is also sold. In reality, there is a big
difference between producing output and selling output. Hence the model gives a
business an unrealistic view of its breakeven position because even if output is
produced, the business may not be able to sell that output.

3. Variable Costs (VC) is the same at each level of Output

The model assumes that variable costs per unit is constant. In reality this is unlikely to
be the case. This is because, at large volumes of output, the firm is likely to be able to
exploit significant economies of scale. (Purchasing Economies of Scale). As firms bulk
buy raw materials and components, significant bulk-buying discounts can be
obtained. This will reduce variable cost per unit and hence, after the shape of the
TVC Curve (but the model doesn’t show this).

4. Outcome only as good as the data on which it’s based

In order to construct a break even chart, assumptions must be made about the likely
fixed costs of the business, the expected variable costs, and a desired price change.
BUT these are only estimates and if the data is wrong, the Fixed Costs and Variable
Cost curves will not be accurate. Similarly, if the firm selects a price that is higher
than the market will bear, the firm will not be able to sell its output and won’t
break-even. So, the break even chart is only as good as the data as the data on which
it is based.

5. Probs in multi product firms

Break even analysis does not work comfortably in a multi product firm i.e a firm that
has many different product lines. The reason is that each product line will break even
at a different output level and each product has different variable costs and a
different price to others. Therefore in multi-product firms, managers, would need to
create separate break even charts for each product line which can become too time
consuming and complicated.

Accounting for Profit

Whilst entrepreneurs typically use the standard profit formula
(profit = sales revenue - total costs).

Accountants identify and calculate 3 different types of profit:

There are 3 types of Profit in Business.

1.​ Gross Profit

Gross Profit = Revenue - Cost of Sales

Cost of sales refers to the costs that directly generate the sales. Eg:
1.​ Raw Materials
2.​ Goods for Resale
3.​ Direct Labour Costs (i.e piece rate labour)
​ NB: Cost of sales typically refers to the business’ Variable Costs.
Variable Costs = a cost that varies directly with output produced eg: raw materials or piece rate labour.

2.​ Operating Profit

Operating Profit refers to how much Profit has been made in total from trading
activities.
Operating Profit = Gross Profit - Other Operating Expenses.

Operating Expenses (also known as overheads) include costs such as :-

1.​ Heating
2.​ Lighting
3.​ Management Salaries
4.​ Marketing Expenses
5.​ Administration expenses
6.​ Distribution Expenses.
NB: Operating Expenses represent the business’ Fixed Costs of Production
Fixed Costs = Costs that do not vary with output produced eg: rent, heating, lighting, advertising.

3.​ Net Profit

Net Profit refers to what is left after all the costs of the Business have been
taken from its revenue.
Net Profit = Operating Profit - Interest

Interest refers to ‘interest that is payable on loans’. We treat any interest

payments that are owed to the bank on loans as an expense in business.
NB: There are 2 types of Net Profit:
1.​ Net Profit before Tax Net Profit = Operating Profit - Interest
 2.​ Net Profit after Tax (Profit for the Period)
Net Profit after Tax= Net Profit Before Tax - Corporation Tax

Corporation Tax = a tax on company profit.

NB: Net profit after tax is also known as ‘the bottom line’ → This means the
final profit figure.

Financial Statements:
By law, businesses are required to produce financial statements that outline the
‘financial performance’ of the business. These would typically be produced by an
accountant.

There are 2 financial documents studied at A level.

1.​ The statement of Comprehensive Income.

(The Profit and Loss account)
→ This Financial Statement shows that profit or less generated by a business
over the previous trading year.
The Structure of The Statement of Comprehensive Income (SCI) :
The Statement of Comprehensive Income

Sales Revenue X

Less (-) cost of Sales X

Gross Profit Y

Less (-) Operating Expenses X

Operating Profit Y

Less (-) Interest on Loans X

Net Profit Before Tax Y

Less (-) Corporation Tax X

Net Profit after Tax Y ← Final Profit Figure.

There are 2 things that can happen with Net Profit after Tax:

1.​ The profit can be retained i.e ploughed back into the business to
finance future growth and expansion.
2.​ The profit can be distributed in the form of ‘dividends’ to shareholders
(i.e the owners of the company.

Net Profit after Tax = Dividends + Retained profit.

(Profit can either be kept or it can be given away).
Importance of the Statement of Comprehensive Income

1.​ Important for the Shareholders:

As the owners of companies, Shareholders will want to know whether the
company they've invested in has made a profit or a loss. By looking at the
Statement of Comprehensive Income, this can be easily seen.

2.​ Is Profit Sustainable? :​

Sustainable profit is profit that is likely to continue into the longer term future.
Sustainable profit is profit that has come from the business’ normal trading
activities i.e selling goods and services. If the majority of the business’ profit
has come from normal trading activity we would consider this to be
sustainable profit. BUT if the majority of this year’s profit had come from a
one-off source eg: selling off an asset (land / delivery vehicle / piece of
machinery), we would class the firm's profit as unsustainable. This is because
the sale of assets cannot continue forever i.e it is not repeatable into the long
term future. The Statement of Comprehensive Income shows ‘where’ the
profit has come from.