5 - Accounting and finance Flashcards
sources of short term finance
- overdraft
- loan
- trade credit
- factoring
- hire purchase
sources of medium term finance
- medium term loan
- leasing
sources of long term finance
- long term loan
- mortgage
- share issues
overdraft
when money is withdrawn from the bank and the available balance goes below zero, the account is overdrawn. an overdraft is a pre arranged amount that can be withdrawn. interest is only paid on the actual amount overdrawn. ‘safety net’ for businesses
loan
loan is granted for a period of time and can be demanded back from the bank if interest payments are not made
trade credit
deferring payments to a supplier (wait for the debtors to pay)
factoring
sells its debts to pay for things and raise finance
often sold to a factoring company (offer a % of the debt and then own that debt)
hire purchase
method of paying for an item in instalments over a period of time, not purchased until the final payment, simply hired
more money will be paid over the period than buying it outright
medium term loan
similar to short term loans. interest is determined by, how much is borrowed, how long for etc
leasing
payments made in instalments but the business never owns it… only if the owner wishes to sell it
if it breaks down, leasing company must deal with it
long term loan/mortgage
amounts of finance are large and the banks require title deeds for security. can adopt a variable or fixed rate mortgage
share issues
where a company issues new shares to shareholders ..
fixed costs..
costs do not vary with the level of output
variable costs..
costs that change with the level of output
direct costs..
costs which go directly into the making of a product
indirect costs.. (overheads)
costs which do not directly go into the making of a product
tax, wages, electricity, heating
stepped fixed costs..
fixed in short term but if production increases may need to purchase another machine - costs have increased
unit costs..
cost of producing one unit
unit cost =
total cost / output
total cost =
fixed costs + variable costs
marginal cost..
cost of producing one extra unit
opportunity cost..
the loss of other alternatives when one thing is chosen
what are forecasts?
estimates of the likely inflows and outflows of cash in a business
what are statements?
the actual figures produced once transactions have occurred
reasons for making forecasts?
- valuable for planning
- helps set prices
- payment terms can be assessed
- managers can monitor and act accordingly
- suppliers and investors can asses the business
limitations of forecasts?
- estimates based on assumption which means they lack accuracy
- seasonal demand variations
- competitor behaviour may change
- changes in; interest rates, economy, technology
liquidity ratios can be used for what?
asses the level of cash in a business
what does too little cash mean for a business?
- inability to meet creditor deadlines
- difficult to buy stock
- additional loans needed, which leads to more interest
what does too much cash mean for a business?
- wasted opportunity to get stock
- borrowing costs are unnecessary
- loss of interest if not invested into the bank
what is ratio analysis?
method of measuring business performance
liquidity?
ability to convert assets to cash (pay off the short term debts)
current ratio =
def
current assets / current liabilities
considers the level of liabilities in relation to assets to see if theres enough cash
acid test ratio =
def
current assets - stock / current liabilities
business cannot be certain it will sell all stock therefore this is more reliable
gearing =
def
non current liabilities / capital employed x 100
considers risk by comparing levels of debt with equity
> 50% suggests potential problems
interest cover =
def
operating profit / interest
used to help decide if a business can afford to repay a loan - higher the better
profitability?
level of profits measured against the business
gross profit =
total revenue - cost of sales
net profit =
gross profit - expenses
gross profit margin =
def
gross profit / revenue x 100]
how much of each £1 of sales you keep as gross profit
considers only direct costs
net profit margin =
def
net profit / revenue x 100
how much of each £1 of sales is kept as net profit
considers both direct and indirect costs
ROCE =
def
operating profit / capital employed x 100
net profit as a % of the capital employed
ROE =
def
profit for the year / equity
measures the ability of a business to generate profits from its investments
what is the difference between ROCE and ROE?
ROE considers the amount of profit generated from quit y whereas ROCE is better as it takes into account shareholders funds and loans
how do you work out capital employed?
shares (equity) + non current liabilities
what is operating profit?
profit before tax and interest
efficiency?
ability to manage assets and liabilities efficiently
asset turnover =
def
turnover / non current assets
measures how effectively a business is able to use its non current assets to generate sales revenue
stock turnover =
def
cost of sales / stock
measures how quickly stock is turned over - higher the better as lower suggests poor stock control
debtor collection period =
def
debtors / revenue x 365
average time customers take to pay - looking for around 28/30 days
how is stock turnover calculated if you want number of days?
stock / cost of sales x 365
creditor payment period =
def
creditors / cost of sales x 365
higher is better - looking for a higher figure than debtor collection period
dividend per share =
def
total dividends paid / number of shares
higher the better
dividend yield =
def
dividend per share / share price x 100
look at this when deciding whether to invest in the first place - higher the better
earnings per share =
def
profit after tax / number of ordinary shares
how much profit each share generates
price earnings ratio =
def
share price / earnings per share
numer of times the share price can be divided by the EPS - higher the better
standard costing?
the cost that a business would normally expect for the production of a product
what are cost centres?
a specific part of the business where costs can be identified and allocated with ease
what are profit centres?
similar to a cost centre however, profits are ascribed to different parts of the business. From this, the managers can judge which products are the most profitable part of the businesses operations
absorption costing?
the indirect costs of a business are absorbed by different cost centres.
contribution/ marginal costing?
a method whereby fixed costs or overheads are ignored and the business considers only the variable costs of production.
consistency?
all accounts being produced in the same way so info is more accurate
going concern?
assumes the business is acting ‘normally’
objectivity?
accounts must be realistic and based on facts, not guesses or opinions
materiality?
calculating realistic figures
only calculating the assets which are of value to the business
prudence?
not over stating the businesses financial position
realisation?
takes place when legal ownership changes hands, not when a payment is made
matching?
recording a transaction when it occurs, not when payment is received
accruel?
record when a transaction occurs
economic entry assumption?
each transaction recorded individually
monetary unit assumption?
all transactions are quantifiable
full disclosure?
cannot hide anything
time period?
usually the financial year/ could be calendar year
cost principle?
recording the actual cost
relevance/ reliability consistency?
data must be relevant and reliable
conservatism?
understate rather than overstate
revenue recognition assumption?
record when the transaction occurs
dividend cover =
profit after tax / dividends
ways to improve stock turnover?
- sell off slow moving stock
- lean production methods i.e. JIT
- negotiate with suppliers
what are some ways in which a business chooses to allocate its costs?
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ads and disads of cost centres?
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ads and disads of standard costing?
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ads and disads of profit centres?
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ads and disads of absorption costing?
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ads and disads of contribution/marginal costing?
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what are the 3 types of investment appraisal?
ARR average rate of return
Payback
Net present value
ARR
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ARR
calc
average/accounting rate of return
calculates the total return for a project to see if it meets the target return
works out a % based on the initial cost of a good
(total net profit / num of years) / initial costs x 100
ads of ARR?
- looks at the whole profitability of a project
- focuses on profitability
- can provide a % return which can be compared with a target
disads of ARR?
- does not take into account cash flows
- takes no account of the time value of money
- treats profits arising late the same as those that arrive early
Payback
how quickly the cost of an investment is paid back - the longer the payback time the higher the risk
ads of payback?
- quick and easy method
- risk of each investment can be compared
disads of payback?
- doesn’t measure the profit of investments
- doesn’t look at the changing value of money
Net Present Value
takes into account the value of money and gives a more realistic measurement of an investment
ads of NPV?
- takes into account the value for money
- more realistic and accurate
- looks at the cashflow during the life of the project
disads of NPV?
- more complicated to measure which takes time and therefore can be more costly
- only as reliable as the data used
- doesn’t take into account external factors
what is depreciation?
when a fixed asset looses its value over time
depreciation =
initial cost - residual value / life of asset
disads of depreciation?
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what is a budget?
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zero bugeting?
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flexible budgeting?
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whats the point in budgeting?
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variance and how to work it out..
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income statements..
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contribution per unit =
price - variable cost per unit
total contribution =
sales x contribution per unit
