2.3 Flashcards
Define Statement of comprehensive income
The Statement of Comprehensive Income is an end of year financial statement that shows all of a businesses income and expenses over the previous twelve months
Each type of profit is calculated within the Statement of Comprehensive Income
The previous year’s figures are also shown for comparison purposes
What does each profit show and their Calculations for
Gross profit
Operating profit
Net profit
Gross profit = revenue - cost of sales
The difference between revenue and the costs directly related to production
Operating profit = gross profit - operating costs expenses
The difference between the gross profit and the indirect expenses involved in operating the business
Net profit = operating profit - finance costs
The difference between the operating profit and any Interest paid and received, as well as any One-off costs
how to meausre profitability
(x profit / sales rev) x 100
3 Ways to improve profitability
Raising prices
If costs remain the same this will improve profitability as the difference between the selling price and costs is now greater depends on price elasticity
Reducing variable costs
This may involve purchasing cheaper/alternative resources, negotiating with suppliers or purchasing in bulk
Reducing other expenses
Reducing staffing levels, relocating to cheaper premises or changing utility companies can reduce expenses
Explain the difference between cash and profit
Profit is simply the difference between revenue generated and business costs
Cash is measured by taking into account the full range of money flowing in and out of a busines
What is the Statement of financial position
A summary of a companys assets, liabilities and equity
What are the calculations for
Working Capital
Net assets
Capital (shareholders equity)
Current assets - current liabilities
Total assets - total liabilities
(Share capital + retained earning) - treasury stock
2 Uses of the statement of financial position
Helps obtain external sources of finance
gives insights into a business performance
2 limitations of the Statement of financial position
Can’t compare
Figures may be manipulated
What is the current ratio + calculation and ideal ratio
Indicates a companys ability to meet its short+long term obligations
Current assets/ current liabilities
In between 1.5 to 3
What is the acid test ratio + calculation and ideal ratio
A measure of a business liquidity. Shows the businesses ability to pay short-term obligations using liquid assets
(Current assets- inventorty)/ current liabilities
At least 1:1or above
eg - An acid-test ratio of 1.5:1 means that the company has $1.50 of liquid assets available to cover every $1.00 of current liabilities. This ratio indicates that the company is in a good position to cover its short-term obligations as they come due.
What is meant by the term working capital and how is it calculated
It is the money available to meet the businesses current obligations
Current assets - current liabilities
Explain how the businesses SIZE may have a different effect on how businesses manage working capital
If a business is large, they are likely to have many assets that could be sold if needed allowing more room for liabilities
Explain how the businesses STOCK LEVELS may have a different effect on how businesses manage working capital
If stock levels are high stock should be sold at a reduced price to recieve money which could pay for liabilities
Explain how the businesses DEBTORS AND CREDITORS may have a different effect on how businesses manage working capital
Credit payors should be made to pay so that the business earns the money for what it gave in return
Why is it important to maintain adequate levels of working capital
It is necessary for a business to remain solvent. By maintaining adequant levels of working capital, the business is ensuring it has the cash flow appropriate to fund its operations and cover costs for the short term
What is business faliure
When a business runs out of cash to spend of covering its bills
Explain 2 non-financial reasons for business faliure
Marketing faliure - poor decisions relating to the marketing mix
New competitors - new competitors that are more effiecient enter the market
Explain 2 financial reasons for business faliure
Cash flow faliures from poor financial planning + management
Economic change
What is the difference between internal and external reasons for business faliure?
Internal - Faliures from inside of the business
External - Faliures caused from changes outside the business
What is meant by overtrading
When a business expands too quickly without the resources to support that growth - eg lack of cash
What is liquidity in business + why its important to be managed
Liquidity is the ability of a business to meet its short term commitments (e.g. payments to creditors) with its available assets
A business that cannot pay its bills will usually fail very quickly, even if they are profitable
Managing liquidity is a key way to manage risk in a business - and helps a business to prepare for the unexpected
Gross, operating and net profit margins definition and calculations
Gross Profit Margin
This shows the proportion of revenue that is turned into gross profit and is expressed as a percentage
Operating Profit Margin
The Operating Profit Margin shows the proportion of revenue that is turned into operating profit and is expressed as a percentage
Operating profit/ revenue x100
Net Profit Margin
The net profit margin (also know as the profit for the year margin) shows the proportion of revenue that is turned into net profit before tax and is expressed as a percentage
Profit for the year/ revenue x100
Ways of improving liquidity
The best way to improve liquidity is to manage the business better
Use cash flow forecasts to identify potential cash flow issues before they arise - and take appropriate action
Budget effectively and consider adopting zero budgeting to carefully control spending
Set clear financial objectives and look for ways to reduce costs and increase income wherever possible
Make use of Overdraft facilities or short-term loans
Current liabilities will increase
The business can spend more money than it has in its bank account
Banks may be reluctant to lend to businesses with cash-flow problems
