Flashcards · 9609 · A Level Topic 10

Finance and accounting (A Level) flashcards

27 cards on A Level Topic 10, subtopics 10.1 to 10.4. Pick a subtopic or study them all.

Study mode needs JavaScript. Every card is listed below, so you can still cover the answers and test yourself.

All 27 cards

For a quick read-through or printing. Cover the right-hand side to test yourself.

10.1 Financial statements

Layout of the statement of profit or loss: Revenue − cost of sales = gross profit. Gross profit − expenses = profit from operations (operating profit). Profit from operations − taxation = profit for the year. Profit for the year − dividends = retained earnings.
Statement of financial position: meaning and contents: Assets, liabilities and equity on one date, showing financial strength. Contents: non-current assets, current assets, current liabilities, net current assets, non-current liabilities, net assets, and equity (issued shares + reserves).
Net realisable value (NRV), and how inventory is valued: NRV = estimated selling price − costs of selling or finishing. Inventory is valued at the lower of cost and NRV. A write-down lowers inventory and current assets, raises cost of sales and lowers profit.
200 units cost 16 each. They can be sold at 18 after spending 4 each on repairs. Value the inventory.: NRV = 18 − 4 = 14 per unit, below cost of 16. Value = 200 × 14 = 2,800 (cost 3,200), so a write-down of 400.
Straight-line depreciation: formula and example (cost 30,000, residual value 3,000, life 6 years): Annual charge = (cost − residual value) ÷ useful life = (30,000 − 3,000) ÷ 6 = 4,500. Net book value after 2 years = 30,000 − 9,000 = 21,000.
Why does depreciation reduce profit but not cash?: It spreads the cost of a non-current asset over its useful life as an expense. The cash was paid when the asset was bought, so recording depreciation moves no cash.

10.2 Analysis of published accounts

Current ratio and acid test ratio: formulas and example (current assets 360, inventory 150, current liabilities 240): Current ratio = current assets ÷ current liabilities = 360 ÷ 240 = 1.5 : 1. Acid test = (current assets − inventory) ÷ current liabilities = 210 ÷ 240 = 0.88 : 1.
Gross profit margin vs operating profit margin (revenue 2,400, gross profit 900, profit from operations 300): Gross profit margin = gross profit ÷ revenue × 100 = 37.5%. Operating profit margin = profit from operations ÷ revenue × 100 = 12.5%. The first ignores expenses; the second includes them.
ROCE: formula and example (issued shares 500, reserves 300, non-current liabilities 200, profit from operations 150): ROCE = profit from operations ÷ capital employed × 100. Capital employed = issued shares + reserves + non-current liabilities = 1,000. ROCE = 150 ÷ 1,000 × 100 = 15%.
Gearing ratio: formula and example (non-current liabilities 200, capital employed 1,000): Gearing = non-current liabilities ÷ capital employed × 100 = 200 ÷ 1,000 × 100 = 20%. High gearing raises interest costs and risk.
Trade receivables turnover and trade payables turnover (days): Receivables days = trade receivables ÷ credit sales × 365. Payables days = trade payables ÷ credit purchases × 365. Example: 150 ÷ 1,825 × 365 = 30 days.
Rate of inventory turnover: formula and example (cost of sales 1,440, opening inventory 200, closing 280): Rate of inventory turnover = cost of sales ÷ average inventory. Average = (200 + 280) ÷ 2 = 240. 1,440 ÷ 240 = 6 times.
Dividend yield, dividend cover and price/earnings ratio: formulas: Dividend yield = dividend per share ÷ market price per share × 100. Dividend cover = profit for the year ÷ annual dividend. P/E ratio = market price per share ÷ earnings per share.
Ways to improve liquidity and to lower gearing: Liquidity: cut inventory, collect receivables sooner, take longer supplier terms, swap short-term for long-term borrowing, issue shares, sale and leaseback. Gearing: repay loans, issue shares, retain profit.

10.3 Investment appraisal

Why do businesses appraise investments?: Capital projects are large, long-lived and hard to reverse; projects compete for limited funds; appraisal tests a project against objectives and shows which forecasts matter most. It makes risk visible but does not remove it.
A line costs £70,000. Net inflows: £20,000, £30,000, £30,000, £20,000 in Years 1–4. Find the payback period.: After Year 2: £50,000. Still needed: £20,000 of Year 3’s £30,000 = 2/3 of a year = 8 months. Payback = 2 years 8 months.
Average rate of return (ARR): formula: ARR = average profit ÷ average investment × 100. Average profit = (total net cash inflows − total depreciation) ÷ years, where total depreciation = cost − residual value. Average investment is usually (cost + residual value) ÷ 2.
Cost £70,000, residual value £10,000, total inflows £100,000 over 4 years. Calculate ARR.: Depreciation = 70,000 − 10,000 = £60,000. Total profit = 100,000 − 60,000 = £40,000; average £10,000 a year. Average investment = (70,000 + 10,000) ÷ 2 = £40,000. ARR = 10,000 ÷ 40,000 × 100 = 25%.
Net present value (NPV): method: Multiply each year’s net cash flow by its discount factor, add them (including any residual value at the end), then subtract the initial cost. The initial cost is paid now (Year 0), so it is not discounted. A positive NPV is worthwhile on this measure.
Payback, ARR and NPV: one strength and one limitation each: Payback: simple, shows how soon cash returns; ignores later cash and the time value of money. ARR: uses all years, a percentage; averaging hides timing. NPV: allows for the time value of money; depends on the discount rate chosen.
Qualitative factors in an investment decision: Strategic fit, effect on employees, brand and reputation, environmental impact, reliability of the forecasts, competitors’ reactions, flexibility and the method of funding.

10.4 Finance and accounting strategy

Contents of an annual report: The financial statements and notes, a directors’ or chair’s report, and an auditor’s report.
Which accounting information do different stakeholders want?: Shareholders: profit and dividends. Lenders: gearing and ability to pay interest. Suppliers: liquidity. Employees: security. Managers: performance against targets.
Effect on ratios of raising funds with debt vs with new shares: Debt: gearing rises; interest rises, so profit for the year and dividend cover fall. ROCE is unaffected by the interest because it uses profit from operations. New shares: gearing falls; ownership is diluted.
A company halves its dividend. What happens to dividend cover and dividend yield?: Dividend cover doubles (for example 2.0 to 4.0) and dividend yield halves (for example 6.0% to 3.0%), at an unchanged share price. Reserves rise.
Large capital spending: likely effect on ROCE: Capital employed rises at once, so ROCE falls until the returns from the investment arrive.
Limitations of published accounts and ratio analysis: Historical data, different accounting policies, window dressing, inflation, seasonality, differences between sectors and business models, no non-financial information, and a single ratio can mislead.