OCR GCSE BUSINESS STUDIES A 29301CS Production Finance

OCR GCSE BUSINESS STUDIES A 293/01/CS Production, Finance and the External Business Environment PRE-RELEASE CASE STUDY

Section 5 Festival T-shirts

Please complete this worksheet while watching the presentation

Lesson objectives • To be able to demonstrate an understanding of job, batch, process and flow methods of production • To be able to calculate, explain and interpret fixed, variable, average and total costs • To be able to analyse and discuss the need for, and use of, finance • To be able to calculate, interpret and analyse cash flow forecasts

Starter What do these 4 T-shirts have in common?

THE BIG QUESTION

Collectors items • BMF Ltd sells a ‘Festival T-shirt’ each year. • A new design is created for each Festival. • The T-shirts have become very popular and are seen as something of a ‘collectors item’ among outdoor pursuits enthusiasts.

Where are the t-shirts sold? • BMF Ltd believes that the T-shirts help to support a positive image for The Festival. • The T-shirts are sold through The Festival website before, during and after The Festival weekend at event venues during the festival.

The big question…. Discuss if The Festival t-shirts be sold at cost price in September?

For an answer first look for facts in the case study 1. 2. 3. 4. What month is The Festival in? What makes the t-shirts special and saleable all year round? Where can BMF Ltd sell The Festival t-shirt all year round? How much are t-shirts sold for in September?

Discuss if The Festival t-shirts be sold at cost price in September? • Fact 1: The Festival is in August • Fact 2: The t-shirts are a collectors item • Fact 3: BMF Ltd could sell The Festival t-shirts after August on their website • Fact 4: In September the t-shirts are sold for £ 5 which was the purchase price from the Chinese supplier • Your conclusion therefore is:

T-SHIRT PRODUCTION

Production method • In previous years, the T-shirts were supplied by a company in China. • The Chinese supplier uses flow production to make standard Tshirts in very large quantities. • Some of these T-shirts are then printed with The Festival design, using batch production.

Production methods • Flow production is used when making the t-shirts • Batch production is used when printing the t-shirts What is flow production? What is batch production?

Videos on how t-shirts are made

Video on production methods

• This is where products are made in huge quantities which is mass production • Products are produced on a continuous production line in a factory 24/7 • It is a very capital intensive automated system, this means there are lots of machines on the production line Flow production

Batch production • This is the production method used when a business wants to make more than one item at a time • Goods are made in batches, and can be switched over to make something different on the same production line – Bread factory also makes crumpets and tortillas – Denby pottery makes a variety of pottery items and designs on the production line, video here – Furniture makers may produce a run of one design of chair before switching to make something else

ECONOMIES OF SCALE

Quoted prices from Chinese supplier Why do prices go down as volume goes up?

Why do prices go down as volume goes up? • This is called economies of scale or EOS for short • As the Chinese manufacturer makes more t-shirts the average cost of each item goes down What does the average cost man?

EOS • Economies of scale (can we say EOS for short) occur when unit costs or average costs fall as a result as an increase in the level of output of the business. • The more the business makes the cheaper it gets per item to make • ANY EOS question should be about how getting bigger means a firm can lower its average costs. • They are like shoes – you need both to be comfortable. Bigger Means Average costs

Video

Types of economies of scale Production / technical Economies Purchasing / bulk buying Economies

Types of economies of scale Production / technical Economies l Purchasing / bulk buying Economies l. Bulk Large scale producers can employ techniques that cannot be used by a small scale producer l A large firm could use computers and technology to replace employees on a production line l Able to transport bulk materials l Mass production means that unit costs are lower buying – being able to buy goods in bulk lowers the average unit price

Bulk-buying / purchasing economies • As businesses grow they need to order larger quantities of production inputs e. g. t-shirt material • As the order value increases, a business obtains more bargaining power with suppliers • It may be able to obtain discounts and lower prices for the raw materials e. g. cotton thread

Production / Technical economies of scale • Businesses with large-scale flow production can use more advanced machinery e. g. The Chinese t-shirt supplier • This may include using mass production techniques, which are a more efficient form of production • A larger firm can also afford to invest more in research and development

Video 2

FINANCING THE T-SHIRT COSTS

Financing the t-shirts • In previous years, BMF Ltd has financed the purchasing and selling costs of the T-shirts using an overdraft. • This year it is considering either asking its supplier for trade credit or taking out a bank loan. What is an overdraft, trade credit, and bank loan?

Overdraft In the graph in Jan and Feb the business would need to borrow from an overdraft until there was an income in March • Some months a business may need extra cash until it has a better month trading. • An overdraft may be organised by the bank which is short term lending of smaller amounts of money • Very high charges and interest rates for an overdraft • Once its arranged on an account a business can dip into it or pay it back as they see fit • If the business goes over this amount the overdraft will be “unauthorised” and the business will be charged heavily

Pros and cons of an overdraft to BMF Ltd

Pros and cons of an overdraft to BMF Ltd • Easy to arrange with the bank for a few days to cover shortfalls of cash on the cash flow • Very expensive method of finance for BMF Ltd • Short-term finance, not ideal for large amounts or over long periods

Trade credit • When one business trades with another they will sometimes need to “buy” goods with trade credit • The seller gives the buyer 30, 60, 90 days to pay • The buyer then has time to sell the goods in their own shop before they have to pay for them • The wholesaler may give the buyer a discount when they use cash instead Buy Now pay later

Pros and cons of trade credit to BMF Ltd

Pros and cons of trade credit to BMF Ltd • BMF Ltd will never run out of t-shirts to sell • BMF Ltd can sell the tshirts first THEN pay the supplier so they won’t have to raise finance for the goods • The t-shirt supplier may charge a higher cost for the t-shirts because of the credit arrangement • This is the first year that BMF Ltd has asked for trade credit so the supplier may say no

What is a bank loan? A bank loan is money lent from a bank to a business on an agreed payment schedule, for example each month Interest is charged on the money loaned, for example 7% on top of what is owed

Pros and cons of a bank loan to BMF Ltd

Pros and cons of a bank loan to BMF Ltd • Can borrow just the right amount of money that they need, over the length of time that suits them • No loss of control of the business, or loss of profit in a profit share • Might be hard for BMF to secure the loan – they may need to offer collateral or security in assets to the bank • Have to pay back the money loaned with interest • May have an arrangement fee to pay • If interest rates up the cost of borrowing may also go up

CASH FLOW FORECAST

Cash flow forecast • BMF Ltd has produced a cash flow forecast related to the sales of The Festival T-shirts. • The cash flow forecast is based on the assumption that T-shirts will be made in China.

This is the cash flow forecast for BMF Ltd • • Its is a business document which plots the possible inflows and outflows to BMF Ltd over the coming year It is a prediction of the future It will help BMF Ltd plan their cash needs for the coming year It does NOT show profit Notice the cash flow is a forecast of what MIGHT happen in 2017

Cash flow forecast is a prediction • Cash flow is a budget – for cash inflows and outflows in a business • Its a forecast because it looks at what might happen to cash in BMF Ltd over the next year

Cash Flow • Cash flow is the relationship between the money flowing into a business and the money flowing out Cash inflows to BMF Ltd What do you think the cash inflows and cash outflows of BMF Ltd might be? Cash outflows to BMF Ltd

Cash Flow • Cash flow is the relationship between the money flowing into a business and the money flowing out. Sales revenue Wages Shareholder investment Advertising Grant from council Speaker fees Sponsorship money Administration Cash inflows to BMF Ltd Venue Policing Cash outflows to BMF Ltd

Cash flow forecast uses • Cash flow is day-to-day running of a business budget • Shows where BMF Ltd will have a shortfall of cash (not enough to pay bills) • Allows BMF Ltd to organise short-term cash borrowing to cover the shortfall Which months might BMF Ltd have a cash shortfall? Example cash flow forecast

What months might BMF Ltd have a cash shortfall? • If you look at the cash flow forecast balance carried forward at the foot of the forecast • In June and July the two months before The Festival is run the business is in negative cash flow How can BMF Ltd improve their cash flow in June and July?

How to improve BMF Ltd’s cash flow a) b) c) d) Reduce waste and economise Cut costs Arrange an overdraft Reduce credit given to customers buying tickets (immediate payment required) e) Discount and promote tickets to encourage more revenue f) Use a cheap supplier g) Organise trade credit with the supplier Which of these solutions will increase inflows and which will decrease outflow?

Inflows and outflows • Inflows of cash into the business • Outflows of cash from the business

Inflows and outflows • Inflows of cash into the business Arrange an overdraft Discount and promote tickets to encourage more revenue • Outflows of cash from the business Reduce waste and economise Cut costs Reduce credit given to customers buying tickets (immediate payment required) Use a cheap supplier Organise trade credit with the supplier

Why trade credit is a genius idea • If BMF Ltd arrange trade credit with the Chinese supplier and get 90 days terms – they could have the t-shirts in June but not pay for them until September – when BMF Ltd have made plenty of revenue through sales to cover the costs of the t -shirts and easily pay the supplier - genius

SALES AND COSTS

Sales and costs The table below shows expected sales and costs of the Festival T-shirts in 2017, and the prices that will be charged, if BMF Ltd continue to use the Chinese supplier.

Costs How much will the t-shirts cost in total? Hint: Total sales x cost

Cost of the t-shirt from the Chinese supplier 5000 x £ 5 each = £ 25, 000

Profit How much profit will BMF make in June July and August? Hint: Profit = TR- TC

Profits June £ 6, 000 - £ 3, 000 = £ 3, 000 July £ 14, 000 - £ 7, 000 = £ 7, 000 August £ 28, 000 - £ 14, 000 = £ 14, 000

How much profit will BMF make in September? What conclusions can you make from this profit figure?

Profits September £ 2, 500 - £ 2, 500 = 0 Conclusions: BMF Ltd should buy 200 less t-shirts this year or sell what is left after The Festival for a small profit at £ 8

You will need the cash flow to answer the following questions This is the cash flow forecast for a business called Bromley Furnishings:

Past paper question 1

Answers to past paper question 1 (i) Bromley Furnishings needs £ 2000 to finance the negative cash flow in the month of March. (ii) • Overdraft • Trade credit • Discount to debtors for early payment

You will need this cash flow diagram for the next question

Past paper question 2 [6]

Answer to past paper question 2

Past paper question 3

Answer to past paper question 3

1. If BMF Ltd wants to improve their cash flow, should they use the new UK supplier? 2. If BMF Ltd want to finance their cash shortfall should they arrange an overdraft with the bank? 3. Should BMF order the same amount of t-shirts next year?

1) No because this will push up their costs and increase the cash outflow 2) They could arrange an overdraft but this will be expensive, they should perhaps organise trade credit with the Chinese supplier, which won’t cost they anything at all. 3) No, they seem to have 200 left over at the end of The Festival which they end up selling for no profit

Glossary • Flow production; This is the production process where items being manufactured are produced in a constant flow, for example coca cola • Batch production; This is where a few items are manufactured at a time, then the batch is changed to make different items. For example a bakery making sausage rolls, then cooking pizza slices • Overdraft; This is a short term loan of funds by a bank to a business, which might be used to cover a shortfall in cash flow, it is very expensive and should only be used rarely • Trade credit; Trade credit is the practice of a supplier giving goods on the understanding that they will be paid by the customer in 30, 60 or 90 days. • Bank loan; Money given by a bank to a business in return for interest payments, around 7% apr • Cash flow forecast; This is the management of cash flowing in and out of a business

Resources written by Sarah Hilton for revisionstation. co. uk