2.3 (Done) Flashcards
Define profit.
The financial gain of a business through trading.
What is the formula for profit?
Total revenue - total costs
What is the formula for gross profit?
Gross profit = Revenue - Cost of sales
What is meant by ‘Cost of sales’?
The direct costs of a business, e.g. for a retailer it’s the cost of buying in stock to re-sell.
What is meant by ‘overheads’?
Indirect costs, e.g. selling and administrative expenses.
What is the formula for operating profit?
Gross profit - Operating expenses
Define net profit.
The profit made by the business for the year.
What is the formula for net profit?
Operating profit - Interest (and exceptional costs)
What does the statement of comprehensive income (SOCI) show?
The income and expenses of a business during the financial year.
What are the three profit margins?
- Gross profit margin.
- Operating profit margin.
- Profit for the year (net profit) margin.
What does the gross profit margin show?
The gross profit made on revenue.
What is the formula for gross profit margin?
Gross profit
——————X100%
Revenue
Are higher or lower gross margins preferable? Why?
Higher gross margins are preferable to lower ones because it means that more gross profit is being made per £1 of sales.
What are two ways the gross profit margin can be increased?
- By raising revenue relative to the cost of sales, by increasing price.
- By cutting the cost of sales; this might be achieved by finding cheaper suppliers of key materials.
What does the operating profit margin show?
The operating profit made on sales revenue.
What is the formula for operating profit margin?
Operating profit
————————— X100%
Revenue
What is the formula for the profit for the year (net profit) margin?
Net profit before tax
——————————— X100%
Revenue
What are two ways to improve profit margins?
- Raising prices.
- Lowering costs.
Why is raising prices a good option for a business where the demand for its products is not too responsive to changes in price?
Because the increase in price will generate more revenue even though fewer units are sold.
What is a problem with raising prices?
It’s always risky because it is never certain how competitors will react.
What are two ways a business can lower its costs?
- Buying cheaper resources.
- Using existing resources more efficiently.
What is a statement of financial position (balance sheet)?
A summary at a particular point in time of the value of a firm’s assets, liabilities and capital.
Define assets and give three examples.
The resources owned by a business, e.g. buildings, machinery, vehicles.
Define liabilities and give two examples.
The money owed by a business, e.g. to suppliers and banks (overdraft or a mortgage).
Define capital.
The money put into the business by the owners.
What is the formula for assets?
Assets = Capital + Liabilities
In a statement of financial position, why does the value of assets equal the value of liabilities and capital?
Because all resources purchased by a business have to be financed either from capital or liabilities.
What are non-current assets (fixed assets)?
Long-term resources that will be used by the business repeatedly over a period of time.
What are non-current liabilities?
Money owed by the business for more than one year.
What are current liabilities?
Money owed by the business that must be repaid within one year.
What are current assets?
Liquid assets, i.e. those assets that will be converted into cash within one year.
What are three examples of non-current assets?
Land, property, vehicles.
What is an example of a current asset?
Inventories, such as stocks of raw materials and finished goods.
Give 2 examples of current liabilities.
Bank loans and bank overdrafts.
What are two examples of non-current liabilities?
Long term bank loans and mortgages.
Formula for net assets?
Total assets - total liabilities.
Define shareholders’ equity.
The amount of money owed by the business to the shareholders.
What are the two financial ratios that can be used to measure liquidity?
- Current ratio.
- Acid test ratio.
What does the current ratio assess?
Whether or not a business has enough resources to meet any debts that arise in the next 12 months.
Formula for current ratio?
Current assets
—————————
Current liabilities
What is the acid test ratio?
A more severe test of liquidity because inventories (stocks) are not treated as liquid resources.
Acid test ratio formula?
Current assets - Inventories
———————————————
Current liabilities
What is working capital?
The amount of money needed to pay for the day-to day trading of a business.
Why does a business need working capital?
To pay expenses such as wages, and to buy components to make products.
Working capital formula?
Current assets - current liabilities
If a business is experiencing liquidity problems, what are two things the business can do to improve liquidity?
- Raise current assets.
- Reduce current liabilities.
What are four measures that might be used to either generate cash or save it?
- A business can increase its cash by borrowing more money on its overdraft.
- Negotiate additional short term or long term loans.
- A business might reduce the amount of stocks it holds.
- Only make essential purchases.
What are three difficulties that a business may face when either generating or saving costs?
- Businesses may not be able to borrow any more money from its overdraft if it’s up to its overdraft limit (and can’t be increased).
- Businesses may find it difficult to negotiate additional loans if it is known that they are short of cash.
- A problem with reducing stock levels is that a business might not have the stocks to cope with an increase in the demand of its products.
