Understanding finance

Investment and Saving Investment: In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price

Saving According to Keynesian economics, the amount left over when the cost of a person's consumer expenditure is subtracted from the amount of disposable income that he or she earns in a given period of time.

Sources of finance Sales of assets: Business might sell off old, obsolete assets which are no longer used by the business to raise additional cash for the business. Retained profits: Businesses usually keep some part of the profit every year for future use. Over a period of time it can total up to a huge amount which can be used for financing the business.

Reduction in working capital: Cutting the stock levels can also help the business to raise additional cash. Short Term Finance: Bank overdraft Trade Credit Medium Term Finance: Hire purchase Leasing Medium term bank loan: A bank loan for 1 year to 5 years.

Long Term Finance: Long term Bank loan Issue of share Debentures

Sources of credit

Budget An estimation of the revenue and expenses over a specified future period of time. A budget is a microeconomic concept that shows the tradeoff made when one good is exchanged for another.

Importance of making budgets Setting Targets: By establishing a well researched and clearly outlined budget, businesses can set targets and goals for achieving a certain level of income, whilst at the same time monitoring expenses Helps understand Cash Flow: A budget allows the business leader to understanding the company's cash flow, which is an essential task that is often overlooked

Controls Costs: It is vital that businesses know how much they are spending and on what. A budget allows for limits to be set on costs. An Unavoidable Process: Budgets are an important element for every business. Every business, whether big or small, must live within its means and know where every penny comes from and goes to.

Cash flow statement An accounting statement called the "statement of cash flows", which shows the amount of cash generated and used by a company in a given period. Cash flow can be attributed to a specific project, or to a business as a whole. Cash flow can be used as an indication of a company's financial strength.

Importance of Cash Flow Statement Helps to identify the sources from where cash inflows have arisen Helps in cash planning and maintaining a proper matching between cash inflows and outflows Shows efficiency of a firm in generating cash inflows from its regular operations Reports the amount of cash used during the period in various long-term investing activities, such as purchase of fixed assets Helps for appraisal of various capital investment programmes to determine their profitability and viability

Cash flow analysis statements are generally separated into three parts: Operating activities Investment activities Financing activities

Cash Flow deficit- When outflow of cash is more than inflow of cash Cash Flow surplus- When inflow of cash is more than outflow of cash

Avoiding Cash flow deficit keeping a record of expenditure/income ensuring fast collection of outstanding debts arranging credit periods with suppliers arranging an overdraft or loan in advance methods to increase sales revenue e.g. marketing.

Profit and loss account Show whether a business has made a PROFIT or LOSS over a financial year. Describe how the profit or loss arose – e.g. categorising costs between “cost of sales” and operating costs.

Operating Revenue Product sales$12,000 Service sales$3,000 Total Operating Revenue$15,000 Operating Expenses Cost of goods sold$7,000 Gross Profit$8,000 Overhead Rent$1,500 Insurance$250 Office suppliese$150 Utilities$100 Total Overhead$2,000 Operating Income$6,000 Other Income (Expenses) Loan interest($500) Earnings Before Income Taxes$5,500 Income Taxes$500 Net Earnings$5,000

Profitability The state or condition of earning a financial profit or gain. Profitability is measured with income and expenses. Income is money generated from the activities of the business.

Importance of Profitability Enables survival of an enterprise Reinvestment of profits for expansion Measuring success of an enterprise Considered as reward for taking a risk Main motive for most enterprises

Types of Costs Direct cost- directly related to Production process Indirect cost- costs after production process is done