Edexcel International A Level Business: Financial planning and Managing finance (YBS11) – Revision Notes

Quick recall for sections 2.3.2 Financial planning and 2.3.3 Managing finance of Unit 2 in the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Business specification (YBS11), Issue 1, September 2017. For full explanations start with the study guide, then test yourself with the practice questions. Wider Unit 2 pages: study guide, revision notes and practice. Hub: Edexcel A Level Business. Checklist: printable checklist. Find weak spots first with the free diagnostics.

The specification says the accounting ratios will not be supplied in the examination, so learn every formula below. All figures are in dollars and every business is invented.

Formulas to know by heart

Measure	Formula
Sales revenue	selling price × sales volume
Total costs	fixed costs + total variable costs
Average cost	total costs ÷ output
Contribution per unit	selling price − variable cost per unit
Break-even output	total fixed costs ÷ contribution per unit
Margin of safety	actual output − break-even output
Net cash flow	inflows − outflows
Closing balance	opening balance + net cash flow
Variance	actual − budget
Gross profit	revenue − cost of sales
Operating profit	gross profit − other operating expenses
Profit for the year (net profit)	operating profit − interest
Gross profit margin	gross profit ÷ revenue × 100
Operating profit margin	operating profit ÷ revenue × 100
Profit for the year margin	profit for the year ÷ revenue × 100
Current ratio	current assets ÷ current liabilities
Acid test ratio	(current assets − inventory) ÷ current liabilities
Working capital	current assets − current liabilities (standard form)

The margin of safety as a percentage of actual output, and the working capital formula, are standard forms rather than formulas printed in the specification.

2.3.2 Financial planning

Sales, revenue and costs

• Fixed costs do not vary with output; variable costs do.
• Average cost falls as output rises while fixed costs are spread wider.
• Improving sales volume or revenue: promotion, product improvement, wider distribution, price change. A price change moves volume and revenue per unit in opposite directions.

Sales forecasting

Point	Notes
Purpose	Base for budgets and cash-flow forecast; plans production, inventory and staffing; supports finance requests
Factors	Consumer trends; economic variables; actions of competitors
Difficulties	Uncertainty; no history for new products; fast-changing trends; competitor reactions; longer forecasts are weaker

Break-even in steps

1. Contribution per unit = price − variable cost per unit.
2. Break-even output = fixed costs ÷ contribution.
3. Margin of safety = actual output − break-even output.
4. Read the chart: revenue line crosses total cost line at break-even; the gap above is profit, below is loss.

Reminder, Alderney Frames: price 24, variable cost 15, fixed costs 18,000. Contribution 9; break-even 18,000 ÷ 9 = 2,000 frames. At 2,600 frames the margin of safety is 600 frames.

Limitations: assumes all output is sold; constant price and variable cost per unit; fixed costs stay fixed; best for one product; relies on forecasts; ignores cash timing and competitor reactions.

Cash-flow forecasts

• Lay out opening balance, inflows, outflows, net flow and closing balance each month.
• Next month’s opening balance is this month’s closing balance.
• Uses: spot shortages early, support borrowing requests, time purchases.
• Limitations: forecast sales may be wrong; late payers and unplanned costs; needs regular updates; says nothing about profit.

Budgets

Point	Notes
Purposes	Targets; control; allocate resources; coordinate; motivate; compare with actual
Based on historical figures	Last period adjusted; quick; repeats old inefficiency
Zero based	Start at zero, justify every item; challenges waste; slower
Variance analysis	Actual − budget. Favourable raises profit; adverse lowers it
Difficulties	Forecast errors; time; padded bids; rigidity; demotivation

For a cost, an actual above budget is adverse. For revenue, an actual above budget is favourable. Always write the label.

2.3.3 Managing finance

Profit and profitability

The statement of comprehensive income (profit and loss account) runs: revenue, minus cost of sales, gives gross profit; minus other operating expenses, gives operating profit; minus interest, gives profit for the year (net profit).

Reminder, Tansley Trims: revenue 210,000; cost of sales 126,000; other operating expenses 52,500; interest 4,200.

Gross profit     = 84,000   margin 40%
Operating profit = 31,500   margin 15%
Profit for the year = 27,300   margin 13%

Ways to increase profit: raise revenue or cut costs. Ways to improve margins: raise prices; cut cost of sales through cheaper materials; cut other operating expenses; cut interest by repaying debt. More volume alone raises profit but not always margin.

Profit versus cash

	Profit	Cash
What it is	Revenue minus costs for a period	Money actually received and paid
Timing	When earned or incurred	When money moves
Credit sales	Counted at once	Arrive later

A profitable business can run out of cash, for example by paying suppliers quickly, offering long credit and building inventory.

Liquidity

The statement of financial position (balance sheet) shows current assets (inventory, trade receivables, cash) and current liabilities (trade payables, overdraft).

Reminder, Mossdale Foods: current assets 50,000 including inventory 32,000; current liabilities 40,000.

Current ratio   = 50,000 / 40,000 = 1.25
Acid test ratio = 18,000 / 40,000 = 0.45

Mossdale looks acceptable on the current ratio but very weak on the acid test, because most current assets are inventory.

Way to improve liquidity	How it helps	Drawback
Sell assets	Cash now	Loses use of the asset
Longer supplier credit terms	Cash leaves later	Suppliers may refuse or raise prices
Factoring	Cash for trade receivables now	Fee; customers may deal with the factor
Just in time inventory	Less cash tied up	Depends on reliable suppliers

Working capital funds day-to-day running. The importance of cash: wages, suppliers and bills fall due on fixed dates, whatever the profit.

Business failure

Internal	External
Poor management of cash flow	Market conditions
Overestimation of sales	Competition
Overtrading (growth outpacing cash)	Economic conditions
Poor inventory control	Exchange rates
Poor marketing	Interest rates
Poor quality	Government regulations
	Supplier problems
	Natural phenomena

Internal causes are within management control; external causes are not, though a business can prepare for them.

Quick self-test

1. Alderney Frames has fixed costs of 18,000 and contribution of 9 a frame. Find break-even output.
2. Sales are 4,000 units and break-even is 3,000 units. State the margin of safety in units and as a percentage of actual output.
3. Fixed costs 12,000; variable cost 4 a unit; output 1,500 units. Find average cost.
4. Find sales revenue for 640 units sold at 27.50.
5. A cost was budgeted at 22,000 and was 24,200. State the variance.
6. Opening balance 1,200; inflows 9,000; outflows 10,100. Find the closing balance.
7. Revenue 210,000; cost of sales 126,000; other operating expenses 52,500; interest 4,200. Find the operating profit margin.
8. Current assets 50,000 (inventory 32,000); current liabilities 40,000. Find the acid test ratio.
9. Current assets 55,000; current liabilities 38,000. Find working capital.
10. Define overtrading.
11. Name two external causes of business failure.
12. State one difference between zero-based budgets and budgets based on historical figures.

Answers

1. 18,000 ÷ 9 = 2,000 units.
2. 4,000 − 3,000 = 1,000 units; 1,000 ÷ 4,000 × 100 = 25% (standard form).
3. (12,000 + 4 × 1,500) ÷ 1,500 = 18,000 ÷ 1,500 = 12.00.
4. 640 × 27.50 = 17,600.
5. 24,200 − 22,000 = 2,200 adverse (10% over budget).
6. 1,200 + 9,000 − 10,100 = 100.
7. Gross profit 84,000; operating profit 31,500; 31,500 ÷ 210,000 × 100 = 15%.
8. (50,000 − 32,000) ÷ 40,000 = 0.45.
9. 55,000 − 38,000 = 17,000.
10. Expanding output or sales faster than the business can fund the cash needed, so it runs short of cash.
11. Any two of: market conditions, competition, economic conditions, exchange rates, interest rates, government regulations, supplier problems, natural phenomena.
12. Zero-based budgets start from nothing and justify every item; historical budgets start from last period’s figures and adjust them.

Where marks are usually lost

• Dividing fixed costs by price instead of contribution.
• Quoting break-even in the wrong unit, or leaving out the unit.
• Carrying the wrong closing balance forward in a cash-flow forecast.
• Writing a variance with no favourable or adverse label.
• Leaving inventory in the acid test.
• Calling every fall in profit a cash problem.
• Giving causes of failure as a list without linking them to the case.
• Claiming factoring or selling assets is free of cost.
• Showing no working on a calculate question, since the command word asks for workings.
• Judging a ratio with no benchmark such as a past year or a rival.

Frequently asked questions

How do you calculate the margin of safety? Margin of safety is actual (or budgeted) output minus break-even output. It shows how far sales can fall before the business starts to make a loss.

What is the difference between the current ratio and the acid test ratio? The current ratio is current assets divided by current liabilities. The acid test ratio removes inventory from current assets first, so it shows whether short-term debts can be covered without selling stock.

What is the difference between historical and zero-based budgeting? A historical budget starts from last period’s actual figures, adjusted for expected changes, which is quick but carries over past inefficiency. A zero-based budget starts at zero, so every item of spending must be justified.

What is overtrading? Overtrading means expanding output faster than the cash available to fund it. It is one of the internal causes of business failure in the Edexcel IAL Business (YBS11) specification.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Business specification (YBS11), Issue 1, September 2017, Unit 2, sections 2.3.2 and 2.3.3 and Appendices 8 and 9, published by Pearson Education Limited.