2.3 - Managing Finance

Question 1

Formula for gross profit

Answer 1

Gross profit = total revenue - cost of sales

Question 2

Formula for operating profit

Answer 2

Operating profit = gross profit - fixed overheads

Question 3

Formula for the profit for the year (net profit)

Answer 3

Profit for the year (net profit) = operating profit - (net financing cost and corporation tax)

Question 4

Define ‘statement of comprehensive income’ or ‘profit and loss account’

Answer 4

Is a document produced by public limited companies that shows revenue, a break-down of different types of costs and different types of profit for a year

Question 5

Formula for gross profit margin

Answer 5

Gross profit margin = (gross profit / sales revenue) x 100

Question 6

Formula for operating profit margin

Answer 6

Operating profit margin = (operating profit / sales revenue) x 100

Question 7

Formula for profit for the year margin or net profit margin

Answer 7

Profit for the year (net profit) margin = (profit for the year (net profit) / sales revenue) x 100

Question 8

2 ways a firm can improve profitability

Answer 8

• Increase selling price • Cut costs

Question 9

Ways of improving profitability - increase selling price

Answer 9

• Will increase profit margin but may decrease overall profit - as an increase in price may lead to drastic decrease in sales volume if the product is price elastic • This will be effective for price inelastic products/services as an increase in price will have little impact on sales volume

Question 10

Ways of improving profitability - cut costs (2)

Answer 10

• This can simply be through using cheaper materials or employing fewer staff however this can damage a firm’s reputation thus revenue • Only where genuine waste can be identified and painlessly removes from the business is cost reduction likely to lead to a straight forwards increase in profitability

Question 11

Differences between net cash flow and profit (2)

Answer 11

• Sales revenue does not equal cash inflows • Costs do not equal cash outflows

Question 12

What is a statement of financial position (balance sheet)

Answer 12

Is a document which shows what business owns as well as what it owes and where it got its money from

Question 13

Formula for current ratio

Answer 13

Current ratio = current assets / current liabilities

Question 14

Formula for acid test ratio

Answer 14

Acid test ratio = (total current assets - inventories) / current liabilities

Question 15

Ways to improve liquidity (4)

Answer 15

• Selling under-used fixed assets such as equipment or machinery • Raising more share capital • Increasing long-term borrowing through loans • Postponing planned investments

Question 16

Importance of cash (3)

Answer 16

• Control cash used • Minimise spending on fixed assets • Plan ahead

Question 17

Importance of cash - control cash used

Answer 17

Involves keeping the amount of cash used as low as possible by reducing stock levels, controlling credit periods offered to customers and gaining as much credit as possible from suppliers, and getting products on sale as quickly as possible

Question 18

Importance of cash - minimise spending on fixed assets

Answer 18

This can be helped by leasing rather than buying new assets - this prevents large outflows of cash draining working capital from the system

Question 19

Importance of cash - plan ahead

Answer 19

This is to estimate carefully the amount of cash that will be needed in the next few months - this ensures that adjustments to the cycle can be made in good time

Question 20

Internal causes of business failure (3)

Answer 20

• Marketing failure • Financial failure • Systems or operations failure

Question 21

Internal causes of business failure - marketing failure

Answer 21

Problems understanding changes in the marketplace or what consumers are really looking for - leads to a decrease in revenue

Question 22

Internal causes of business failure - financial failure (2)

Answer 22

• Managers need to manage finances actively, planning ahead and make adjustments when necessary • Failing companies sometimes stumble into cash flow crises without seeing them coming

Question 23

Internal causes of business failure - systems or operations failure (2)

Answer 23

• If IT systems don’t provide the right people within the business with the information needed things can start to go wrong • If physical systems breakdown e,g manufacturing or ordering stock the business will find itself unable to satisfy demand for its product and will rapidly lose customers

Question 24

External causes of business failure (4)

Answer 24

• Changes in technology • New competitor • Economic change • Behaviour of banks

Question 25

External causes of business failure - change in technology (2)

Answer 25

• A major technological advancement can destroy a company’s sales rapidly • As a product struggles to compete against a better product, price cutting is almost assured and ultimately the company may fail to operate at a break even point

Question 26

External causes of business failure - new competitor

Answer 26

New competitors that are able to operate far more efficiently may cause such a large effect as to drive existing businesses out of the market and out of business

Question 27

External causes of business failure - economic change (2)

Answer 27

•In times of economic downturn firms that sell luxury goods may encounter a decrease in sales • if economic growth does not recover quickly, some business will find it hard to continue operating above their break-even point potentially leading to business failure

Question 28

External causes of business failure - behaviour of banks

Answer 28

A failure to supply credit to businesses or forcing businesses to accept unreasonably high interest rates can lead to business failure

Question 29

Financial cause of business failure (2)

Answer 29

• Operating below break-even for a sustained period of time • Having insufficient cash flow - meaning the business cannot cover its current liabilities

Question 30

Non financial causes of business failures (4)

Answer 30

• lack of management control - as in not developing a credible business plan • Failure to understand markets and key customers - e.g underestimating competitors’ levels of customer loyalty • Failure to administer the business properly - e.g poor methods of motivation and leadership of staff • Significant illegality or unethical behaviour leading to substantial business cost