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A LEVEL BUSINESS - TH > 2.3 managing finance > Flashcards

2.3 managing finance Flashcards

1
Q

how to calculate profit:

A

total revenue - total costs

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2
Q

what are the three types of profit?

A

-gross profit
-operating profit
-profit for the year/net profit

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3
Q

define gross profit

A

the money made from selling a product after the cost of producing the product has been deducted

(only tells us a little bit about profit as it only includes direct costs)

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4
Q

how to calculate gross profit:

A

revenue - cost of sales

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5
Q

define operating profit

A

what is left after all the costs of a
business have been taken from its revenues

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6
Q

what are operating expenses / administration expenses
(+ examples)

A

day to day costs that aren’t directly attributed to the product

(rent, equipment)

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7
Q

how to calculate operating profit

A

gross profit - other operating expenses

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8
Q

what is profit for the year/net profit?

A

the actual profit the business has made (taking into account interest and all costs)

(tells us much more, because we have taken away EVERY cost)

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9
Q

how to calculate profit of the year/net profit:

A

operating profit +/- interest

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10
Q

what are profit margins?

A

the proportion of sales revenue that has been converted into profit

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11
Q

what is a gross profit margin useful for?

A

a useful indicator for analysing how a business has performed in terms of its direct trading activity

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12
Q

how to calculate a gross profit margin:

A

gross profit/revenue x 100

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13
Q

how is an operating profit margin useful?

A

-it takes into account the performance of a business more fully, as the calculation takes into account direct and indirect costs
-tells us how effectively a business turns its sales into profit

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14
Q

how to calculate an operating profit margin:

A

operating profit/revenue x 100

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15
Q

how is a net profit margin useful?

A

-it takes into account all revenues and costs incurred by the business
-it is a good measure of how effectively the business performed over the financial year

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16
Q

how to calculate the net profit margin

A

net profit/revenue x 100

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17
Q

what is interest?

A

a percentage of the amount of money borrowed that must be repaid in addition to the original amount borrowed

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18
Q

how to calculate interest

A

total repayment - borrowed amount/borrowed amount

x100

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19
Q

what is ratio analysis?

A

the different ratios that are used to analyse how a business is performing

(eg: gross profit margin)

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20
Q

what can a statement of comprehensive income be called?

A

a profit and loss account

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21
Q

what is the purpose of the statement of comprehensive income?

A

to list all of the business’s actual income and expenditure for a year

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22
Q

why are statements of comprehensive income done?

A

-if a profit is made, tax must be paid to the government
-management may want to compare statement to past years
-to compare to rivals
-shareholders/investors may be interested in the profitability
-statement may encourage new investors to

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23
Q

what order are the headings in a profit & loss account?

A

1) sales revenue
2) cost of sales
3) gross profit
4) operating expenses
5) operating profit
6) interest
7) net profit/profit of the year

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24
Q

what are costs of sales?

A

the direct costs associated with the production and sale of the product or service

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25
Q

what can a profit and loss account be used to calculate?

A

profitability ratios/ratio analysis

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26
Q

what we can find out from a statement of comprehensive income:

A

-changes in sales revenue
-changes in the direct costs of sales
-how well a business is managing its operating costs
-the profitability of a business

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27
Q

is an increase in cost of sales always bad? (analysing a statement of comprehensive income)

A

no, if sales revenue has increased, cost of sales will also increase

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28
Q

how can cost of sales be decreased & what is the impact of this?

A

a supplier can be changed, however this could worsen quality and then lower sales revenue

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29
Q

what effect would increasing marketing have on a statement of comprehensive income?

A

operating expenses would increase but there could be a greater gain in sales revenue

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30
Q

what does operating profit exclude that profit for the year includes?

A

debts/interest

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31
Q

4 reasons why businesses are unprofitable

A

-no demand
-selling at the wrong price
-low contribution per unit
-poor management of costs

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32
Q

what are two main ways to improve profitability?

A

-increase revenue
-decrease costs

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33
Q

how can revenue be increased?

A

-increase quantity sold
-increase selling price
-create awareness and desire through marketing
-add value to the product (increase benefits and features)

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34
Q

increasing quantity sold to improve profitability (why?, will it work?, why it might not work)

A

why?
higher sales volumes = higher revenue

will it work?
-depends on elasticity of demand
-sales value may fall if price has to be reduced to achieve higher sales volumes
-does business have capacity to sell more?

why it might not work
-competitors are likely to respond
-marketing efforts may be unsuccessful
-fixed costs might rise

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35
Q

increasing selling price to improve profitability (why?, will it work?, why it might not work)

A

why?
-higher selling price = higher revenue
-no need for extra production capacity
-maximises value extracted from customers

will it work?
-depends on price elasticity of demand
-it will work if customers remain loyal and still perceive product to be good value

why it might not work
competitors are likely to respond (lower prices)
-customers may decide to switch to competitors

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36
Q

how can costs be decreased?

A

-reduce variable costs per unit
-reduce fixed costs
-improve efficiency

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37
Q

decreasing variable costs to improve profitability (why?, will it work?, why it might not work)

A

why?
-higher profit margin on each item produced and sold
-customers do not notice a change in price

will it work?
-if suppliers can be persuaded to offer better prices
-if quality can be improved through lower wastage

why it might not work
-customers may notice a decrease in product quality

38
Q

decreasing fixed costs to mprove profitability (why?, will it work?, why it might not work)

A

why?
-drop in fixed costs causes higher profits
-substantial savings can be made by cutting unnecessary overheads

will it work?
-yes, if quality, customer service & output are unaffected
-a business can nearly always find savings in overheads

why it might not work
-might reduce ability of business to increase sales

39
Q

are cash flow and profit the same?

A

no

profit is an absolute position when all costs have been deducted from revenue.
however, cash flow is an ongoing concern

40
Q

what is profit?

A

revenue - costs

41
Q

what is cash flow?

A

inflow - outflow

42
Q

2 examples of cash flow being different to profit

A

1) if a customer is given credit (get item now, pay later) then you have revenue as the sales are recognised but you don’t have the cash until the payment is made

2) if you take out a loan, you have an inflow, however that is a cost in terms of revenue

43
Q

how are cash and profit linked?

A

-to make a profit, a business must manage cash flow so that it can pay expenses and running costs

44
Q

benefits of a good cash flow

A

-can pay suppliers & employees on time
-can handle unforeseen events
-can expand

45
Q

drawbacks of poor cash flow

A

-can’t pay suppliers & employees on time (relationships ruined)
-could become bankrupt due to unexpected events

46
Q

what is a statement of financial position
(balance sheet)?

A

-financial document that records the assets and liabilities of a business
-snapshot of the business’s equity

47
Q

which three items does a balance sheet show?

A

-assets
-liabilities
-capital

48
Q

why is a statement of financial position also called a balance sheet?

A

businesses aim to have their total net assets equal to their equity

49
Q

what are assets?

A

-all the items that the business owns
-the money it has in the bank
-the money it is owed by other people

50
Q

what are fixed assets/non current assets?

A

-used to operate the business
-will be held for more than a year

51
Q

what are current assets? (+ examples)

A

assets that the business expects to use or sell within the year (stock, debtors)

52
Q

what are liabilities? (+ examples)

A

all the money the business owes to others (suppliers, bank)

53
Q

what are current liabilities? (+ examples)

A

money that must be paid back within a year (suppliers, bank overdraft)

54
Q

what are long term/non-current liabilities? (+ example)

A

money being paid back over a longer period (loans)

55
Q

what are examples of tangible & intangible non-current assets)

A

tangible → land
intangible → patents

56
Q

what are debtors?

A

people who owe the business money

57
Q

what are creditors?

A

people who the business owes money

58
Q

how to calculate net assets:

A

non current assets + current assets

  • (subtract)

non current liabilities + current liabilities

59
Q

what is equity?

A

the shareholders’ stake in the company

60
Q

what will equity always equal?

A

net assets

61
Q

what is working capital?

A

the amount of money available to run the business

62
Q

why are balance sheets important?

A

-the government uses them to work out how much tax should be collected
-banks use them to decide whether to give a business a loan or not
-investors use them to decide if they should invest or not

63
Q

what is liquidity?

A

the ability of a business to pay its debts and liabilities in cash when they fall due

64
Q

how do cash and liquidity link?

A

-cash is the most liquid asset (cash is a current asset) that a business has and any business would quickly fail if it ran out of cash

65
Q

what do liquidity ratios do?

A

assess whether a business has sufficient cash/ enough current assets to be able to pay its debts

66
Q

how to calculate current ratio:

A

current assets/current liabilities

(expressed as a ratio, eg: 2.1)

67
Q

what does a current ratio of 1.5 - 2.5 suggest?

A

-efficient management of working capital
-good liquidity

68
Q

what does a current ratio below 1 suggest?

A

-cash problems
-can’t cover short term liabilities
-poor liquidity
-poor working capital management

69
Q

what does a current ratio around 10 suggest?

A

current assets are high:
-cash could be invested
-stock may be wasted

-good liquidity
-poor working capital management

70
Q

how to calculate acid test ratio

A

current assets - stock/current liabilities

71
Q

why is an acid test ratio more useful than a current ratio?

A

it does not take into account the inventories (stock) of a business, for many businesses there is no guarantee that inventories can be quickly turned into cash

72
Q

what is the target for an acid test ratio and why?

A

1.5:1 - 1:1

73
Q

what is a bad result from an acid test ratio?

A

under 1

74
Q

issue with acid test ratio

A

-doesn’t show how long it will take for debtors to pay, if debtors will take long then liquidity is actually poor

75
Q

when should an acid test ratio be higher?

A

-when a business has a low stock turnover (you’re not selling your products quickly enough)

-if a business has no negotiation over creditors (eg: can’t negotiate reduced payments)

76
Q

how to calculate working capital

A

current assets - current liabilities

77
Q

ways to improve liquidity

A

-use an overdraft facility
-delay payments
-take out credit agreements with suppliers
-sell off current assets

78
Q

how cash flow links to working capital

A

cash flow management is a crucial day-to-day activity for every business

79
Q

main causes of cash flow problems

A

-low profits
-excess inventories held
-allowing customers too much credit & too long to pay
-seasonal demand

80
Q

issues with excess stock

A

-excess stocks tie up cash
-increased risk that stocks become obsolete

81
Q

issues with allowing customers too much credit

A

-customers who buy on credit are called trade debtors
-offeing credit is a good way of building sales
-but late payment is a common problem

82
Q

debt factoring

A

-the selling of debtors (money owned to the business) to a third party
-this generates cash

83
Q

why it’s difficult to start a business

A

-high rate of business failure for start-ups
-difficult to test a model without trading
-easy to be over-optimistic in the business plan
-competitor response is often aggressive

84
Q

internal factors of business failure

A

-poor planning
-cash flow
-marketing
-lack of skills

85
Q

how poor planning causes business failure

A

-can lead to important factors not being addressed
-may be the root cause of other issues, such as cash-flow problems or poor marketing through a lack of understanding of customer needs

86
Q

how lack of skills causes business failure

A

may include technical skills, such as financial management, or leadership capacity

87
Q

external factors for failure

A

-competition
-legislation
-market conditions
-economic conditions

88
Q

how competition causes business failure

A

a new competitor or an overcrowded market can lead to a shortage of demand and falling sales

89
Q

how legislation causes business failure

A

new legislation can often mean increased costs as a business adjusts its products and processes to comply

90
Q

how market conditions cause business failure

A

changes in consumer tastes can cause demand to fall

91
Q

financial reasons for failure

A

-poor management of cash flow
-inadequate financing

92
Q

non-financial reasons for failure

A

-lack of management control
-significant external shock

A LEVEL BUSINESS - TH (7 decks)

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