2.3-managing finance

Question 1

+What are the 3 types of profit, and what are the formulas?

Answer 1

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

Question 2

What is an income statement?

Answer 2

It shows a businesses income and expenses for the year
Businesses also use it to calculate their gross, operating and profit for the year

Question 3

What is profitability?

Answer 3

the long term value of a financial decision

Question 4

What is a profitability margin and what are the 3 different ones?

Answer 4

-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

Question 5

why are profitability margins useful?

Answer 5

To compare- competitors, previous years
Shows risky businesses the profit margins they need to survive

Question 6

What are the 2 ways of increasing profitability?

Answer 6

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)

Question 7

What is the distinction between cash and profit?

Answer 7

-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

Question 8

What is the statement of financial position?

Answer 8

-shows the liabilities and new worth of a business on a given date
-also known as balance sheet

Question 9

What are the 2 types of assets?

Answer 9

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)

Question 10

What is a current liability?

Answer 10

debts that the business will have to pay within the year (overdrafts, dividends, money owed to debtors)

Question 11

What is the formula for net current assets? (working capital)

Answer 11

current assets - current liabilities

Question 12

what is the formula for assets employed?

Answer 12

fixed assets + net current assets

Question 13

What is capital employed?

Answer 13

-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

Question 14

What is liquidity?

Answer 14

How easily a business can convert its assets into cash, and pay its day-to-day costs.

Question 15

What is a current ratio?

Answer 15

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

Question 16

What is an acid test ratio?

Answer 16

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.

Question 17

How can you improve liquidity?

Answer 17

1- increase current assets
2- decrease current liabilities
3-manage accounts properly
-reduce stock
-use JIT

Question 18

What is working capital?

Answer 18

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

Question 19

What is the working capital cycle?

Answer 19

The length of time between buying the raw materials, and getting cash for the sales of the finished product.

Question 20

Problems with insufficient working capital

Answer 20

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.

Question 20

What are internal factors that lead to business failure?

Answer 20

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

Question 21

What external factors case a business to fail?

Answer 21

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