2.3-managing finance Flashcards
+What are the 3 types of profit, and what are the formulas?
1-Gross profit
gross profit = revenue - cost of sales
2- Operating profit
Operating profit=gross profit - other operating expenses
3- Profit for the year(net profit)
-The amount of profit that goes to the owners
Profit for year= operating profit-tax and interest
What is an income statement?
It shows a businesses income and expenses for the year
Businesses also use it to calculate their gross, operating and profit for the year
What is profitability?
the long term value of a financial decision
What is a profitability margin and what are the 3 different ones?
-Shows the % of turnover that is profit
gross profit margin=gross profit x 100= …%
—————-
turnover
operating profit margin=operating profit x 100= …%
———————-
turnover
profit at end of year margin= paeoy x100 …%
————
turnover
why are profitability margins useful?
To compare- competitors, previous years
Shows risky businesses the profit margins they need to survive
What are the 2 ways of increasing profitability?
1- Increase revenue
-you can decrease the price to gain more sales, but the revenue may not increase
-you can increase the price to gain more revenue per item, but may lead to less sales
2- reduce the costs
-buy cheaper resources/supplies
-use cheaper labour
-use existing resources more efficiently
-upgrade machinery (to decrease the unit cost)
-reduce waste (recycling, lights, reuse)
What is the distinction between cash and profit?
-If goods are sold on trade credit, payments aren’t made immediately- businesses may receive the cash at the start of the new year which will affect the cash balance, not profit.
-If owners introduce cash into the business, it will affect the cash flow but not profit
-If you purchase or sell assets, it will affect the cash not the profit as its not treated as a cost on the income statement
What is the statement of financial position?
-shows the liabilities and new worth of a business on a given date
-also known as balance sheet
What are the 2 types of assets?
1- Fixed assets
-assets that the business will have for a long time
-they will depreciate over time
-they can be tangible (buildings, vehicles) or intangible (reputation, branding)
2- current assets
-assets in the business for a short period of time- can become cash within a year (stock, debtors, cash)
What is a current liability?
debts that the business will have to pay within the year (overdrafts, dividends, money owed to debtors)
What is the formula for net current assets? (working capital)
current assets - current liabilities
what is the formula for assets employed?
fixed assets + net current assets
What is capital employed?
-Long term liabilities- debts that the business pays off over many years (loan)
-share capital - money invested by shareholders or owners so counts as a liability as if the business folded, money would be owed to them.
-Reserves- retained profit kept by the business
What is liquidity?
How easily a business can convert its assets into cash, and pay its day-to-day costs.
What is a current ratio?
shows The ability to meet short term debt obligations (pay bills)
current ratio=
current assets
——————— = ?:1
current liabilities
-A businesses should be between 1.5-2.0
-If its higher, money isn’t being used effectively
What is an acid test ratio?
A current ratio but excluding stock as a business may not be able to sell stock quick enough
Acid test ratio = current assets - stock
—————————— = ?:1
current liabilities
-1.0-1.2 is generally good, and if it’s higher than 1.4, it means the business has too much cash.
How can you improve liquidity?
1- increase current assets
2- decrease current liabilities
3-manage accounts properly
-reduce stock
-use JIT
What is working capital?
The amount of capital that a business has to pay it’s day-to-day costs
Working capital=current assets-current liabilities
-If a business doesn’t have enough working capital, they can’t pay off their debts
What is the working capital cycle?
The length of time between buying the raw materials, and getting cash for the sales of the finished product.
Problems with insufficient working capital
1- banks:
-may not be willing to lend loans/overdrafts as they add additional charges
-banks can recall debt at anytime
2-suppliers:
-can cause poor relationships as suppliers may reduce or refuse credit periods, and may not benefit from discounts that they could gain if they had a good relationship with their suppliers.
-opportunities may be missed- may need to refuse big orders if they can’t get the supplies
-may not be able to bulk buy and benefit from economies of scale
-lack of funds may slow development in the long term and could lead to insolvency.
What are internal factors that lead to business failure?
1-Financial failure- when a business can’t cover it’s expenses
-bad management of working capital, and unit costs increasing
2-non-financial- poor communication within departments
-can cause a firm to fail to innovate as they aren’t in touch with consumer needs
What external factors case a business to fail?
1-Financial factors- economic change
-less consumer income
-change in exchange rates
2-non-financial -
-competitors
-changes in consumer needs
-changes in technology- can give competitors a competitive advantage
