Flashcards · IB Diploma Programme Business · Topic 3

Unit 3: Finance and accounts flashcards

46 cards on Topic 3, subtopics 3.1 to 3.9. Pick a subtopic or study them all.

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3.1 Introduction to finance

Role of finance for businesses: To meet start-up costs, day-to-day cash needs, and growth or change, and to give a cushion in a poor period.
Capital vs revenue expenditure: Capital: spending on non-current assets that last beyond a year, or on improving them (machines, vehicles, buildings). Revenue: everyday running costs whose benefit ends within the year (wages, materials, rent, ordinary repairs).
Classify: a USD 12,000 van and USD 1,350 of fuel and tyres: The van is capital expenditure (USD 12,000). The fuel and tyres are revenue expenditure (USD 1,350).
How is capital expenditure usually financed, compared with revenue expenditure?: Capital spending usually needs longer-term finance. Revenue spending is met from trading cash.

3.2 Sources of finance

Internal sources of finance: Personal funds (for sole traders), retained profit (profit after tax minus dividends) and sale of assets.
Share capital vs loan capital: Share capital gives ownership and may earn dividends but needs no repayment; ownership is diluted. Loan capital is repaid with interest whatever the profit, often needs collateral, but keeps ownership.
Overdraft vs trade credit vs leasing: Overdraft: flexible short-term borrowing, high rate, can be recalled. Trade credit: pay suppliers later, no interest if on time. Leasing: no large upfront cost, but total cost can exceed buying and no ownership.
Crowdfunding, microfinance providers and business angels: Crowdfunding: many small online backers; tests demand. Microfinance: small loans for those refused by banks; costly. Business angels: a wealthy individual who gives funds plus advice for a share of ownership.
Loan of USD 7,000 at 6% simple interest for 3 years vs leasing at USD 250 a month for 36 months: Loan: interest 7,000 × 0.06 × 3 = 1,260, total USD 8,260. Lease: 250 × 36 = USD 9,000, so the lease costs USD 740 more and gives no ownership.
Matching a source of finance to the situation: Match the term to the use (short for short, long for long), consider the amount, the cost, the control the owner will give up, and what the business can actually access. A seasonal stock gap suits an overdraft; a new factory a long-term loan or share issue.

3.3 Costs and revenues

Fixed vs variable costs: Fixed: total does not change with output (rent, insurance). Variable: total changes with output (raw materials, packaging). Fixed cost per unit falls as output rises.
Direct vs indirect costs (overheads): Direct: can be traced to a particular product (ingredients for one product). Indirect: supports the whole business and cannot be traced to one product (head-office rent, general admin).
Exam trap: variable vs direct: Variable describes behaviour (does the total change with output?); direct describes traceability (can it be linked to one product?). Every cost carries one label from each question.
Total revenue and revenue streams: Total revenue = price × quantity sold, before costs. A revenue stream is a distinct source of revenue (a product line, service, fee, membership); total revenue is the sum across streams.
1,500 posters at USD 6; variable cost USD 1.80 each; fixed costs USD 2,370. Profit?: Revenue 9,000; variable costs 2,700; total costs 5,070; profit USD 3,930.

3.4 Final accounts

Profit and loss account vs balance sheet: A period versus a point in time.
Profit and loss account: from sales revenue to retained profit: Cost of sales = opening inventory + purchases − closing inventory. Gross profit = revenue − cost of sales; − expenses = operating profit; − interest = profit before tax; − tax = profit after tax; − dividends = retained profit.
Balance sheet: accounting equation, net assets and working capital: Assets = liabilities + equity. Net assets = total assets − total liabilities = equity. Working capital = current assets − current liabilities.
What do lenders look for in a business's final accounts?: Ability to repay, assets that could be security.
Intangible assets: types: Patents, trademarks or brand names, copyright, licence or franchise rights, and goodwill (paid above the value of a business's identifiable net assets). Hard to value and can lose worth quickly.
Straight line vs units of production depreciation: Straight line = (cost − residual value) ÷ useful life: (38,000 − 8,000) ÷ 5 = 6,000 a year. Units of production = (cost − residual value) ÷ total expected units × units used: 0.10 per km × 72,000 km = 7,200. (HL only)

3.5 Profitability and liquidity ratio analysis

Gross profit margin and profit margin (guide formulae): Gross profit margin = gross profit ÷ sales revenue × 100. Profit margin = profit before interest and tax ÷ sales revenue × 100.
ROCE and capital employed: ROCE = profit before interest and tax ÷ capital employed × 100, where capital employed = non-current liabilities + equity. Example: 56,000 ÷ 320,000 × 100 = 17.5%.
Current ratio and acid test: stock 40,000, debtors 18,000, cash 7,000; current liabilities 50,000: Current ratio = 65,000 ÷ 50,000 = 1.3. Acid test = (65,000 − 40,000) ÷ 50,000 = 0.5. The acid test removes stock, the slowest current asset to turn into cash.
Strategies to improve profitability ratios: Raise the selling price, find cheaper inputs, improve the product mix, cut waste, lower overheads; for ROCE, raise profit or reduce capital employed. Each has a trade-off, such as lost sales or lower quality.
Strategies to improve liquidity ratios: Turn stock into cash, speed up debtor payments, extend supplier credit, replace short-term debt (such as an overdraft) with long-term finance, sell unused assets.

3.6 Efficiency ratio analysis (HL only)

Stock turnover in times and in days: Times = cost of sales ÷ average stock. Days = average stock ÷ cost of sales × 365. Average stock = (opening + closing) ÷ 2. Example: 455,000 ÷ 65,000 = 7.0 times, or 52.1 days. (HL only)
Debtor days and creditor days: Debtor days = debtors ÷ total sales revenue × 365. Creditor days = creditors ÷ cost of sales × 365. Example: 24,000 ÷ 292,000 × 365 = 30.0 debtor days. (HL only)
Gearing ratio: non-current liabilities 60,000, equity 90,000: Gearing = non-current liabilities ÷ capital employed × 100 = 60,000 ÷ 150,000 × 100 = 40.0%. Lower it by repaying debt from retained profit or issuing shares. (HL only)
Insolvency vs bankruptcy: Insolvency: being unable to pay debts as they fall due. Bankruptcy: a legal process or status that can follow it. Rules differ between countries. (HL only)
Strategies to improve efficiency ratios: Stock turnover: just-in-time ordering, drop slow lines. Debtor days: credit control, early payment discounts, factoring. Creditor days: negotiate longer terms with suppliers, within the terms. (HL only)

3.7 Cash flow

Profit vs cash flow: Profit follows earning and incurring (sales revenue minus costs). Cash flow follows money actually received and paid. Credit sales, asset purchases, loan repayments and depreciation drive them apart.
Sales 9,000 (5,500 cash, 3,500 on credit); costs 6,800 paid in cash. Profit and net cash flow?: Profit = 9,000 − 6,800 = 2,200. Net cash flow = 5,500 − 6,800 = −1,300. The 3,500 owed by customers explains the gap.
Working capital and liquidity: Working capital = current assets − current liabilities: funds for day-to-day operations. Liquidity is the ability to pay short-term debts when due. Too little risks missed payments; too much leaves resources idle.
Cash flow forecast: layout and limitations: Opening balance + inflows − outflows = closing balance, which becomes next month's opening balance; depreciation is left out. Limits: relies on assumptions; unexpected events; less accurate further ahead.
Strategies for cash flow problems: Short timing gap: overdraft, delay supplier payments. Slow customers: chase receivables, shorter credit terms, factoring. Large purchase: lease, sale and leaseback, delay. Excess stock: reduce stock. Persistent losses: cut costs, raise prices.

3.8 Investment appraisal

Payback period with uneven returns: cost 90,000; returns 25,000, 35,000, 45,000, 30,000: Cumulative 25,000, 60,000, then 105,000. After two years 30,000 is still needed: 30,000 ÷ 45,000 = 0.67, so payback = 2.7 years (about 2 years 8 months).
Average rate of return (ARR): the guide's formula, with the same project: [(total returns − capital cost) ÷ years of use] ÷ capital cost × 100. (135,000 − 90,000) ÷ 4 = 11,250; 11,250 ÷ 90,000 × 100 = 12.5%.
Payback vs ARR: main strength and weakness: Payback: shows speed of recovery, liquidity and risk, but ignores returns after payback. ARR: uses the whole project life to compare with a target, but ignores when returns arrive.
Net present value (NPV): NPV = sum of present values of returns − original cost, where present value = return × discount factor. A higher discount rate gives smaller factors, so NPV falls. (HL only)
NPV at 6% for the 90,000 project (factors 0.9434, 0.8900, 0.8396, 0.7921): Present values 23,585 + 31,150 + 37,782 + 23,763 = 116,280. NPV = 116,280 − 90,000 = +26,280. (HL only)

3.9 Budgets (HL only)

Cost centre vs profit centre: Cost centre: costs are collected but no revenue is attributed (HR, IT support). Profit centre: costs and revenue are both identified, so profit can be found (a shop, a branch). (HL only)
Budget and variance: Budget: a financial plan for a future period, in money terms. Variance = actual − budget; favourable if it increases profit compared with budget, adverse if it reduces it. (HL only)
Budgeted materials 8,000, actual 7,600. Variance?: 7,600 − 8,000 = −400, which is −5.0% of budget. It is a cost below budget, so favourable. (HL only)
Revenue +1,350 F; materials +640 A; wages +280 A. Profit variance?: 1,350 − 640 − 280 = +430 favourable: the revenue gain outweighs the extra costs, even though two cost variances are adverse. (HL only)
Importance and limits of budgets in decision-making: Benefits: planning, coordination, control of spending, accountability, variances point to problems. Limits: forecasts can be wrong, rigidity, padded budgets, a variance shows what happened, not why. (HL only)