Flashcards · 7115 · Topic 5

Financial information and decisions flashcards

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

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Three main reasons a business needs finance: Start-up capital, capital for expansion, and additional working capital.
Internal and external sources of finance: Internal: retained profit, owner’s savings, sale of assets, reducing stock or collecting debts sooner. External: bank loan, overdraft, trade credit, share issue, grants, micro-finance, crowd-funding.
Debt and equity: Debt: provided by a lender, repaid with interest, control unchanged, interest still due in a bad year. Equity: provided by owners or shareholders, no set repayment, rewarded by dividends, control may be shared.
Micro-finance and crowd-funding: Micro-finance: very small loans, often to people who cannot get bank loans. Crowd-funding: many people each giving a small amount, usually online; it also tests demand.
Four factors in choosing a source of finance: Size and legal form of the business, the amount required, the length of time needed, and existing loans.
A company needs $120,000 for ovens that last ten years. Why a long-term bank loan rather than an overdraft?: The loan matches the length of the need. An overdraft is short-term and can be withdrawn. Shares would avoid interest but share ownership.

Cash-flow forecast: A prediction of cash expected to come in and go out over future months, with the expected balance each month.
Net cash flow and closing balance: Net cash flow = inflows − outflows for the month. Closing balance = opening balance + net cash flow, and becomes next month’s opening balance.
Opening balance 1,500, inflows 4,200, outflows 4,500. Find the closing balance.: Net cash flow = −300. Closing balance = 1,500 − 300 = 1,200.
Ways to overcome a short-term cash problem: An overdraft, delaying supplier payments, asking debtors to pay sooner; also delaying a purchase, selling an unused asset or the owner adding money.
Working capital, and an example: Working capital = current assets − current liabilities. Inventories 9,000 + receivables 3,000 + cash 500 = 12,500; payables 4,000 + overdraft 1,000 = 5,000; working capital = 7,500.
Is a negative cash balance the same as a loss?: No. A negative balance is a cash shortage. Profit and cash differ: a credit sale adds to profit now but brings in cash later.

Profit, and why it matters: Profit = revenue − total costs. It is a reward for the owners’ risk and enterprise, and retained profit is a source of finance with no interest and no new owners.
Layout of an income statement for a limited company: Revenue − cost of sales = gross profit − expenses = profit − tax − dividends = retained profit
Why can profit and cash move in opposite directions?: Credit sales count as revenue before the cash arrives; buying a non-current asset uses cash but is not a cost against this year’s revenue in the same way; a loan brings in cash but is not profit.
Gross profit and profit; profit and retained profit: Gross profit is before expenses; profit is after expenses. Retained profit is the profit left after tax and dividends.
Limitations of an income statement: It covers a past period only, does not show cash, forecasts based on it rely on assumptions, and it does not show what the business owns or how it is financed.

Classify: premises, inventories, payables, bank overdraft, five-year bank loan, share capital: Premises: non-current asset. Inventories: current asset. Payables: current liability. Overdraft: current liability. Five-year loan: non-current liability. Share capital: equity.
Net assets and equity: Net assets = total assets − current liabilities − non-current liabilities. Equity = share capital + retained profit, and equals net assets.
Capital employed (standard form): Capital employed = equity + non-current liabilities, which also equals total assets − current liabilities.
Non-current assets 200,000, current assets 60,000, current liabilities 80,000, bank loan 50,000. Find net assets and working capital.: Net assets = 200,000 + 60,000 − 80,000 − 50,000 = 130,000. Working capital = 60,000 − 80,000 = −20,000, a weak short-term position.
What happens when inventories are sold at cost for cash?: Inventories fall and cash rises by the same amount, so current assets stay the same but are more liquid. The cash can reduce an overdraft.

Profitability and liquidity: Profitability: how well a business earns profit compared with its revenue or the capital invested in it. Liquidity: the ability to pay short-term debts when they are due.
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.
Current ratio and acid test ratio formulas: Current ratio = current assets ÷ current liabilities. Acid test ratio = (current assets − inventories) ÷ current liabilities.
Revenue 90,000, cost of sales 54,000, profit 13,500, capital employed 90,000. Find the GPM, profit margin and ROCE.: GPM = 36,000 ÷ 90,000 × 100 = 40%. Profit margin = 13,500 ÷ 90,000 × 100 = 15%. ROCE = 13,500 ÷ 90,000 × 100 = 15%.
Current assets 36,000 (inventories 18,000), current liabilities 24,000. Find the current ratio and acid test ratio.: Current ratio = 36,000 ÷ 24,000 = 1.5. Acid test = 18,000 ÷ 24,000 = 0.75.
Which ratios do a lender and a supplier look at?: A bank or other lender: liquidity and profit, to decide whether and on what terms to lend. A supplier: the current ratio and acid test, to decide whether to give credit.