2.3 how do businesses survive?1 business management 2.3 how do businesses survive?

2.3 How do businesses survive? 1

BUSINESS MANAGEMENT

2.3 How do Businesses Survive?


In this unit you will learn …• About the need to plan• What is a saleable product• What are costs• What is break-even analysis• Why is Cash Flow important• What are Final Accounts• What are ratios and percentages used for• Why is Market Research important• How to make comparisons between years

or businesses


The Need to Plan!All organisations should have goals or objectives so that they know what they are aiming for. Suggest objectives for the following organisations …

Oban High SchoolOban Saints

OxfamTesco


Tesco


OxfamTesco



The Need to Plan!

Business organisations must prepare a business plan/forward plan (set objectives) to ensure that they:

• Meet customer needs and wants• Manage costs effectively• Stay competitive


Types of Decisions to be Made

product or service? how many to make?how many workers? when will I make a profit?

what price? new product? size of product? how much will it cost? what materials?


Saleable Products/Services

Saleable products must…• be of suitable quality• in the quantities required• at a suitable price• available to the correct consumer

market• which consumers want to buy


Covering Costs!

• ALL types of organisation, whether they exist to make a profit or not, must consider COSTS! What costs would be involved in running these organisations?

Oxfam

Tesco

Oban High School

Oban Saints


Example of CostsFraser decides to make

a jar of jam

Fruit £0.50Sugar £0.20

Mum’s gas £0.10Jar and cover £0.05

Q: What is the lowest price Fraser could

charge in order to cover his costs?

A: £0.85

Q: If Fraser charged £1.00 for the jar of jam, how much profit would

he make?

Answer: £1.00-£0.85 £0.15


Another Example• Fraser goes into mass production of jam

Sales Income £15,000 Fruit £7,000

Sugar £3,000Jars and covers £300

Light and heat £500Staff wages £2000

Rent of factory £1,000Insurance £200

Fraser will prepare a profit and loss

account to calculate his profit from making jam


From the Profit and Loss Account, answer the following

questions …1. What are the total

costs?2. What is Fraser’s

income?3. Jam sells at £1 per

jar. How many jars were sold?

4. How could Fraser increase his profit?


1. What are the total costs?

2. What is Fraser’s income?

£15,000

3. Jam sells at £1 per jar. How many jars were sold?

£15,000/£1 = 15,000 jars

4. How could Fraser increase his profit?

Increase price of jam eg to £1.50

Reduce costs


Important points about Costs!

• Profit is the amount made after costs are paid.

• Businesses must cover costs or they will make a loss

• Some new businesses will aim to only cover costs or break-even (ie not make a profit or a loss) in the first few years - to get established

• Forecasting income and costs allows businesses to make decisions and plans eg – get a loan or overdraft in a month where income is low.


•

• Click for video• Click for video

http://www.bbc.co.uk/learningzone/clips/what-costs-are-involved-in-a-business/10961.html

http://www.bbc.co.uk/learningzone/clips/making-the-full-costs-transparent/11146.html

What is a Budget?

A plan that a business prepares for the year ahead. It is based on the objectives of the business and provided targets for the employees to achieve.

Why Prepare a Budget?

• Greater control over the future of the business – gives targets and reduces RISKS

• Weaknesses or difficulties can be anticipated before they happen

• Less uncertainty and fear about future• Decisions can be made eg to purchase

asset?

What does a Cash Budget look like?

Can you see any possible problems?

700-19005500Closing Balance

12600214008900

10000Van

300300300Wages

110011001100Heat and Light

200020002000Rent

920080005500Purchases

Payments

133001950014400

152001400012500Sales

Receipts

-190055001900Opening Bal

MarchFebruaryJanuary

CASH BUDGET FOR FIONA’S FLOWER SHOP

What could Fiona do about the February cash flow problem?

• Arrange a bank loan • Arrange an overdraft - when there

is a negative balance in the bank account.

• Buy the van on Hire Purchase• Try to increase sales• Find a cheaper supplier

Using a Spreadsheet for Budgets

• Can perform calculations (formula)• Can run scenarios (what ifs?)• Can display results on charts

Importance of Planning and Control

• Businesses must cover costs or they will make a loss

• Some new businesses will aim to only cover costs or break-even (ie not make a loss) in the first few years - to get established

• Profit is the amount made after costs are paid.

• Forecasting income and costs allows businesses to make decisions and plans eg – get a loan or overdraft in a month where income is low.

Types of Costs

Fixed Costs are those costs which stay the same irrespective of how much you sell or produce (eg rent for premises, insurance premiums)

Variable Costs are those costs which increase directly as sales or production increases (eg power to machines, some wages [where workers are paid according to how much they produce])

Costs &Revenues (£)

Quantity

SalesRevenue

Fixed Costs

Total Costs

Break-even point

G/C

Value of Sales and

Costs

No of Items Sold

Costs &Revenues (£)

Quantity

Break-even point

For an explanation of the shaded areas see next slide

G/C

Area of loss

Area of Profit

BREAK-EVEN CHART

The green shaded area (to the left of BEP) shows the losses made at the appropriate levels of salessince Total Cost is greater the Sales Revenue.

The blue shaded area (to the right of BEP) shows the profits made at the appropriate levels of salessince Sales Revenue is greater the Total Cost.

Therefore the BE chart allows you to calculate whether a profit or loss will be made at any level of sales.

G/C

Fixed or Variable?

• Rent• Chocolate• Staff wages• Packaging• Icing sugar• Coffee• Electricity• Ribbons

• Flour• Advertising

material• Insurance• Lolly sticks• Ice cream• Tea • Milk• Website designer

TRADING AND PROFIT & LOSS ACCOUNT

TRADING ACCOUNT

Gross Profit =

difference between money from selling goods and cost of buying or making these goods

PROFIT & LOSS ACC

Net Profit =

gross profit less expenses (overheads), eg wages, rent, lighting

C

Trading and Profit & Loss Account

C

FRASER’S TRADING, PROFIT AND LOSS ACCOUNT

5000NET PROFIT

100050Rent

50Insurance600Wages

300Light and Heat

Less Expenses

6000GROSS PROFIT

4000Cost of Sales

1200Less Closing Stock

5200

4200Add Purchases

1000Opening Stock

Less Cost of Sales

10000Sales

££TRADING ACCOUNT –

everything related to sale of goods and

services

PROFIT AND LOSS

ACCOUNT – for all

expenses other than goods and services

BALANCE SHEETShows the VALUE of the business on a

particular date

C

ASSETS LIABILITIES and CAPITAL

=

FIXED ASSETS – last longer than a

year

CURRENT ASSETS – last less than a year

CURRENT LIABILITIES – to be repaid in less

than a year

CAPITAL – the owner’s share of

the business

LONG TERM LIABILITY –

repaid over more than a year

What are ratios?

• Ratios are calculated from final accounts– Trading, profit and loss account– Balance sheet

• Comparison between years• Comparison between organisations• How well has the company done• Has the business improved or not?

Trading, Profit and Loss Account Ratios

• Gross Profit % RatioGross Profit Sales

Yr 1 = 60%Yr 2 = 45%A higher percentage is GOOD!A lower percentage is BAD!

X 100Calculating this ratio helps to check:• the price paid for raw

materials • wastage or damage to stock


• Net Profit % Ratio

Net Profit Sales

Yr 1 = 28%Yr 2 = 36%

A higher percentage is GOOD!A lower percentage is BAD!

X 100The Net Profit percentage helps to monitor the amount a business spends on expenses

• Rate of Stock Turnover

Cost of SalesAverage Stock (Opening+Closing

Stock/2)It is important that a business does not buy too

much stock.A rate of 1.3 times means that stock has changed

only once in a year! Rate of turnover depends on product.

A fishmonger will have a rate of 300 times a year!


Balance Sheet Ratios

• Working Capital RatioMeasures how easily short-terms debts

can be paid off

Current Assets : Current Liabilities

2 : 1 Good1 : 2 Bad

Liquidity indicates whether a business has sufficient cash assets to meet its debts. Any business with insufficient assets to cover its debts will fall into financial difficulty.


• Acid Test Ratioo Stock is least liquid asseto Ratio should be greater than 1

Current Assets - Stock : Current Liabilities

1.2:1 Good1:2 Bad

Liquidity indicates whether a business has sufficient cash assets to meet its debts. Any business with insufficient assets to cover its debts will fall into financial difficulty.


• Return on Capital Employed (ROCE)

Net Profit Capital EmployedX 100

If the return is the same as or lower than that to be earned from a safe investment (eg saving in the Bank or Building Society) then the Sole Trader will have to decide whether it is worthwhile for him/her to continue in business.

Ratio Summary

Properly used, ratios can tell interested parties about 3 main areas of a business’s finances:

• Profitability – Gross Profit %, Net Profit %, Return on Capital Employed

• Liquidity – Working Capital Ratio, Acid Test

• Efficiency – Rate of Stock Turnover

Find out what is happening in the market at the moment

Help predict the future – for product development

Find out why sales have fallen

Investigate if there is a market for a product/service

Market Research

Reasons for Market Research

C

Sampling – may not reflect nations views

People’s behaviour not always predictable

Wording of the questions – leading?

Attitude and personality of the interviewers?

Market Research

Problems with Market Research

C

Use of Ratios

Compare between 2 years – can see if company has improved, has new idea worked, etc.Compare between companies - you can compare 2 similar companies to see if one is better managed, better resources, etc.Compare against expected (forecast) performance

C

SUMMARY OF RATIOS

PROFITABILITY - return on capital employedgross profit percentagenet profit percentage

LIQUIDITY - working capital ratio acid test ratio

EFFICIENCY - rate of stock turnover

C

On the sheet provided, calculate Fraser’s

Gross Profit percentage for years 1 and 2 and comment

Net Profit percentage for years 1 and 2 and comment

Rate of Stock Turnover for years 1 and 2 and comment

Comment:Fraser’s Gross Profit percentage has decreased

which means that he is less profitable in buying and selling. This could be because the cost of buying stock has increased. He may have to look for cheaper suppliers or increase the selling price of his goods.

Comment:Fraser’s Net Profit percentage has decreased which

means that his expenses are relatively more expensive this year. He should consider changing his electricity supplier as the cost of light and heat has doubled.

CommentThe average stock has remained the same, however

the rate of turnover has increased which proves that Fraser has been selling stock efficiently – he is moving stock more often.

Comparing Businesses

Comment on Futura’s Gross Profit Percentage and Stock Turnover in comparison with the other 3 businesses.

Rate of

BALANCE SHEET RATIOSRatio Coy

ACoy B

Comment

Working Capital Ratio

2:1 5:1 Business A has ideal ratio whereas B is probably keeping too much stock

Acid Test Ratio

1:1 0.5:1

Business A has ideal ratio whereas B could be in trouble if creditors demanded payment

Return on Capital Employed

15% 5% A is getting a good return. B should consider if the effort of running the business is worth the effort. Possible to earn a similar rate of return by investing in a high interest account

You Need to Know…

• Why businesses plan

• What is a saleable product

• What are costs• What is break-even

analysis• Why is Cash Flow

important• What are Final

Accounts used for

• Why do businesses calculate ratios and percentages

• What role does Market Research play in planning

• How to make comparisons between 2 years or 2 businesses

2.3 how do businesses survive?1 business management 2.3 how do businesses survive?

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