Finance — section overview
Section 3.6 covers how businesses manage money: from sources of finance to understanding financial statements and evaluating performance. Financial literacy is crucial for business success.
What 3.6 covers
| Sub-topic | Key ideas |
|---|---|
| 3.6.1 | Sources of finance: internal, external, short vs long term |
| 3.6.2 | Cash flow management and forecasting |
| 3.6.3 | Financial terms and calculations |
| 3.6.4 | Financial performance analysis: ARR, break-even, profit margins |
Sources of finance
Internal (within the business):
- Retained profit
- Selling assets
- Reducing stock levels (sale of inventory)
External:
- Bank loans (long-term)
- Overdraft (short-term, flexible)
- Share capital (equity — Ltd/PLC)
- Crowdfunding
- Venture capital
- Leasing
- Grants (government, EU)
- Trade credit
Key distinction: equity finance (shares — no repayment, but dilutes ownership) vs debt finance (loans — must repay with interest, but retain ownership).
Cash flow
Cash flow: movement of money in and out of a business.
Cash flow ≠ profit: a business can be profitable but still run out of cash (timing mismatch).
Cash flow forecast: projects monthly cash inflows and outflows.
Formula: Closing balance = Opening balance + Net cash flow Net cash flow = Total inflows − Total outflows
Solutions to poor cash flow:
- Negotiate extended credit terms with suppliers
- Chase debtors more quickly
- Invoice factoring
- Arrange overdraft facility
Financial performance
Revenue: price × quantity sold
Costs: fixed costs (don't change with output — rent, salaries) + variable costs (change with output — materials, commission)
Total costs = fixed costs + variable costs
Profit = revenue − total costs
Gross profit = revenue − cost of goods sold (COGS) Net profit = gross profit − overheads/expenses
Key ratios and analysis
Gross profit margin (%) = (Gross profit / Revenue) × 100
Net profit margin (%) = (Net profit / Revenue) × 100
Average Rate of Return (ARR) = (Total net profit / Number of years) / Investment × 100
Break-even = Fixed costs / (Selling price − Variable cost per unit)
Common exam mistakes in 3.6
- Profit = cash — profit is an accounting concept; cash is actual money available
- Break-even formula inversion — the denominator is contribution (selling price − variable cost), not total costs
- ARR — dividing by wrong number — divide total profit by number of years FIRST, then divide by investment
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