Flashcards · 9609 · AS Topic 5

Finance and accounting (AS Level) flashcards

34 cards on AS Topic 5, subtopics 5.1 to 5.5. Pick a subtopic or study them all.

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5.1 Business finance

Why do businesses need finance?: To start up (premises, equipment, first inventory, costs before revenue arrives), to grow (new site, machinery, new products, takeover) and to survive (pay wages and suppliers when revenue is weak or a customer fails to pay).
Cash vs profit: Profit = sales revenue − costs over a period; a credit sale counts when it is made. Cash is money held and usable now; a credit sale brings no cash until the customer pays. A profitable business can run out of cash.
Bankruptcy vs liquidation vs administration: Bankruptcy: an individual (sole trader or partner) cannot pay personal debts. Liquidation: the business is closed and its assets sold to pay creditors. Administration: an outside administrator tries to rescue the business or sell it as a going concern.
Working capital: formula and example (current assets £31,000, current liabilities £22,500): Working capital = current assets − current liabilities = £31,000 − £22,500 = £8,500. It is not the same as cash: cash is only one current asset.
Capital expenditure vs revenue expenditure: Capital expenditure: spending on non-current assets used for more than a year (machinery, vehicles, buildings). Revenue expenditure: spending on day-to-day running (wages, materials, rent, repairs).
Ways to improve the management of trade receivables: Set clear credit terms and check customers first, invoice and remind promptly, offer an early-payment discount (weighing its cost), and consider debt factoring, while weighing the risk that strict terms push customers to rivals.

5.2 Sources of finance

Internal sources of finance: Owner’s investment, retained earnings, sale of unwanted assets, sale and leaseback, and working capital.
Share capital vs debentures: Share capital: sold to owners; never repaid, but dilutes control and dividends are expected. Debentures: a long-term loan with fixed interest and a fixed repayment date; no loss of control.
Leasing vs hire purchase: Leasing: renting equipment with no big payment; the asset is never owned. Hire purchase: paying in instalments with interest added; the asset is owned after the last instalment.
Bank overdraft vs bank loan: Overdraft: short term and flexible; interest only on the amount used; can be recalled. Loan: a fixed sum for a set period with interest; may need security.
Debt factoring, venture capital and crowd funding: Debt factoring: selling unpaid invoices for cash sooner, at less than full value. Venture capital: investment in a risky or growing firm for a share of ownership. Crowd funding: small sums from many people, usually online.
A £5,000 overdraft at 15% a year is used for 2 months. Calculate the interest.: £5,000 × 15% × 2/12 = £125. A 12-month loan of £5,000 at 10% would cost £500, so for a two-month need the overdraft fits better.
Factors in choosing a source of finance: Cost (interest, fees, dividends), flexibility, control (shares, partners and venture capital share it; loans do not), use (match long-term needs with long-term finance) and existing debt.

5.3 Forecasting and managing cash flows

Cash flow forecast: An estimate of the cash a business expects to receive and pay out in future periods, showing the expected balance at the end of each.
Net cash flow and closing balance: formulas: Net cash flow = total cash inflows − total cash outflows. Closing balance = opening balance + net cash flow. This month’s closing balance becomes next month’s opening balance.
Opening balance £1,200, inflows £5,400, outflows £6,100. Find the closing balance.: 1,200 + 5,400 − 6,100 = £500.
Where do credit sales and depreciation go in a cash flow forecast?: Credit sales go in the month the customer pays, not the month of sale. Depreciation is left out: it is an accounting entry, and no cash leaves the business.
Limitations of cash flow forecasts: Sales estimates are uncertain (especially for a new business), costs and supplier terms change, customers may pay late or default, managers can be over-optimistic, outside events can outdate it, so it needs regular updating.
Methods of improving cash flow: Bring cash in sooner (shorter customer credit, early-payment discount, debt factoring, overdraft, loan), raise cash from assets (sale of assets, sale and leaseback), delay outflows (longer supplier credit, leasing) and reduce outflows (cut costs, lower inventory).
A factor advances 80% of £10,000 of invoices and charges a 2% fee on invoice value. Find the advance, the fee and the balance paid later.: Advance = £8,000. Fee = £200. Balance later = 10,000 − 8,000 − 200 = £1,800.

5.4 Costs

Fixed vs variable costs; direct vs indirect costs: Fixed costs stay the same whatever the output in the short run (rent); variable costs change with output (ingredients). Direct costs can be traced to a product; indirect costs (overheads) cannot. A cost can be direct and fixed.
Average cost and marginal cost: Average cost = total cost ÷ output. Marginal cost = the extra cost of producing one more unit.
Contribution: per unit and in total: Contribution per unit = selling price − variable cost per unit. Total contribution = total revenue − total variable costs. Contribution pays towards fixed costs; profit is what is left after them.
Break-even output: formula and example (price £9, variable cost £4, fixed costs £12,000): Break-even output = fixed costs ÷ contribution per unit. Contribution = £9 − £4 = £5. £12,000 ÷ £5 = 2,400 units.
Margin of safety: formula and example (actual output 2,900, break-even 2,400): Margin of safety = actual output − break-even output = 500 units. As a percentage of actual output: 500 ÷ 2,900 × 100 = 17.2%.
Output for a target profit (fixed costs £12,000, target £3,000, contribution £5): (fixed costs + target profit) ÷ contribution per unit = (12,000 + 3,000) ÷ 5 = 3,000 units.
Full costing vs contribution costing: Full costing shares (apportions) fixed costs across products; the basis is a judgement. Contribution costing does not share fixed costs; it suits one-off decisions such as special orders but can hide long-run losses.
When should a special order be accepted?: If the price is above variable cost (positive contribution), spare capacity exists and fixed costs do not rise, after checking non-financial factors such as regular customers expecting the same price.
Break-even analysis: limitations: Assumes all output is sold, a constant price and constant unit variable cost, and fixed costs that do not step up; it is based on forecasts and one product only.

5.5 Budgets

Budget, and its purposes: A financial plan with targets for a future period. Purposes: measure performance, allocate resources, and control and monitor spending.
Incremental, flexible and zero budgeting: Incremental: last period plus or minus a percentage (quick, but repeats old inefficiency). Flexible: variable items adjusted to actual output (fairer comparison). Zero: start from £0 and justify every item (challenges spending, but slow).
Favourable vs adverse variances: Revenue above budget, or costs below budget: favourable. Revenue below budget, or costs above budget: adverse. Judge by the effect on profit, not whether the number is bigger.
Budget: 2,000 covers and £8,000 of food. Actual: 2,400 covers and £9,900 of food. Find the variance.: Flex the budget: £8,000 ÷ 2,000 = £4 a cover; £4 × 2,400 = £9,600. Variance = £9,900 − £9,600 = £300 adverse.
Benefits and drawbacks of budgets: Benefits: clear targets, coordination, motivation, early warning. Drawbacks: time-consuming, forecast errors, short-term focus, can be rigid.