Flashcards · 0264 · Topic 5

Financial information and decisions flashcards

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

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5.1 Business finance

Why businesses need finance: Start-up capital, expansion or growth, replacing non-current assets, investing in new technology, and working capital for everyday costs.
Working capital: The money available for everyday expenses: current assets − current liabilities. Example: current assets $12,200 and current liabilities $7,700 give working capital of $4,500.
Internal sources of finance: Owners’ investment, retained profit, sale of unwanted assets, and working capital. Cheaper and quicker, and owners keep control, but the amount is limited.
Leasing and hire purchase: the difference: Leasing: renting an asset; the business never owns it. Hire purchase: a deposit then instalments; the business owns the asset after the final payment. Both cost more in total than paying cash.
Bank overdraft and bank loan compared: Overdraft: spend beyond the account balance up to a limit; flexible, interest only on the amount used, but dear if kept long and can be recalled. Loan: a fixed sum for a set period, with predictable repayments that must be made even in a bad year.
Share capital and venture capital: Share capital: a company sells shares; large sums with no repayment, but ownership and profits are shared. Only companies can issue shares. Venture capital: a specialist investor takes a stake, bringing money and advice; owners lose some control.
Factors that affect the choice of source of finance: The size of the business, its legal form, the amount required, the length of time it is needed, existing loans, cost, and the purpose. Match the length of the finance to the length of the need.
A machine costs $6,000 cash, or a $1,200 deposit plus 12 payments of $440 on hire purchase. What is the extra cost of hire purchase?: Total = 1,200 + 12 × 440 = 1,200 + 5,280 = $6,480. Extra cost = 6,480 − 6,000 = $480.

5.2 Cash flow forecast

Cash flow forecast: An estimate of the cash expected to come in and go out of a business over future months, showing the expected cash balance.
Net cash flow and closing balance formulas: Net cash flow = total cash inflow − total cash outflow. Closing balance = opening balance + net cash flow. This month’s closing balance is next month’s opening balance.
Opening balance 1,500, inflow 4,000, outflow 4,600. Find the net cash flow and closing balance.: Net cash flow = 4,000 − 4,600 = −600. Closing balance = 1,500 − 600 = 900.
Why might a profitable business run out of cash?: It may sell on credit, so customers pay later than bills fall due. Profit does not mean cash is available when it is needed.
Four ways to overcome a short-term cash flow problem: Arrange an overdraft, delay payments to suppliers, ask customers to pay more quickly, and delay the purchase of non-current assets. Most move or cover the shortage rather than create cash.
Why does a business prepare a cash flow forecast?: To see when shortages or surpluses are expected and act in time, to plan when to buy stock or equipment, to support a request to a lender, and to compare forecast with actual figures.

5.3 Profit and loss

Revenue and profit formulas: Revenue = selling price per unit × number of units sold. Profit = total revenue − total costs.
Why profit matters to private sector businesses (four reasons): Reward for risk-taking, a source of finance (retained profit), a measure of success, and to attract investors.
The lines of a statement of profit or loss: Revenue less cost of sales = gross profit less expenses = profit
A firm sells 7,000 candles at $8. Cost of sales is $21,000 and expenses are $27,500. Find gross profit and profit.: Revenue = 7,000 × 8 = $56,000. Gross profit = 56,000 − 21,000 = $35,000. Profit = 35,000 − 27,500 = $7,500.
Retained profit: Profit kept in the business rather than paid out to the owners. It can pay for assets or stock without interest.
Revenue rose but profit fell. What does this suggest?: Costs (cost of sales or expenses) rose faster than revenue. Review each cost line, or the price.

5.4 Statement of financial position

Statement of financial position: A snapshot of what the business owns (assets) and owes (liabilities) on one date.
Non-current and current assets, with examples: Non-current assets: kept for more than a year, such as property and machinery. Current assets: cash or expected to become cash within a year, such as inventory, trade receivables and cash.
Non-current and current liabilities, with examples: Non-current liabilities: due after more than a year, such as bank loans. Current liabilities: due within a year, such as trade payables and an overdraft.
Trade receivables and trade payables: Trade receivables: owed to the business by customers (a current asset). Trade payables: owed by the business to suppliers (a current liability).
Capital employed (standard form): Capital employed = total assets − current liabilities. It is the long-term finance in the business.
Total assets $96,000, of which current assets $16,000. Current liabilities $9,000. Find working capital and capital employed.: Working capital = 16,000 − 9,000 = $7,000. Capital employed = 96,000 − 9,000 = $87,000.

5.5 Analysis of accounts

Profit and profitability: Profit is an amount. Profitability measures it in proportion, against revenue or capital employed.
Gross profit margin, profit margin and ROCE formulas: Gross profit margin = gross profit ÷ revenue × 100. Profit margin = profit ÷ revenue × 100. ROCE = profit ÷ capital employed × 100. All are percentages.
Revenue $320,000, cost of sales $208,000, expenses $80,000, capital employed $250,000. Find the gross profit margin, profit margin and ROCE.: Gross profit = 112,000, so GPM = 112,000 ÷ 320,000 × 100 = 35%. Profit = 32,000, so profit margin = 10%. ROCE = 32,000 ÷ 250,000 × 100 = 12.8%.
Gross profit margin and profit margin: the difference: The gross profit margin ignores expenses; the profit margin includes them.
Liquidity: A business’s capacity to meet short-term debts when payment is due, using cash or assets that can quickly be turned into cash.
Current ratio and acid test ratio formulas: Current ratio = current assets : current liabilities. Acid test ratio = (current assets − inventory) : current liabilities. The acid test removes inventory, the least liquid current asset.
Current assets $120,000 (inventory $48,000), current liabilities $80,000. Find the current ratio and acid test ratio.: Current ratio = 120,000 ÷ 80,000 = 1.5:1. Acid test = 72,000 ÷ 80,000 = 0.9:1.
Profitability and liquidity: the difference: Profitability is long-run earning power; liquidity is the short-run ability to pay bills.
Users of accounts and what they look for: Owners and managers: performance and return. Employees: job security. Suppliers: liquidity before selling on credit. Lenders: liquidity and profit before lending. Government: profit for tax.
Limitations of ratio analysis: Figures are historical; the statement of financial position is a snapshot; one ratio is not enough without comparisons; non-financial factors are left out; ratios show that something changed, not why.