Accounting And Finance Flashcards
Explain sources of finance
How a business raises finance to buy things for the business such as machinery
Exalting internal sources of finance
Money that comes from the business and its owners
Explain external sources of finance
Financing options that come from outside the business
Distinguish between short term and long term sources of finance
Short term is a year or less and long term is any longer
Explain a bank loan
Getting a loan from the bank for a set period of time and at a certain rate of interest
Explain benefits of a bank loan
Greater certainty of funding
Lower interest than an overdraft
Appropriate financing methods
Explain drawbacks of a bank loan
Requires security
Interest paid on full amount outstanding
Harder to arrange
Small businesses often excluded
Explain leasing
A form of renting an asset, giving beneficial use of the asset without owning it
Explain benefits of leasing
Predictable cash flow
Asset owner carries the risk
Lower interest than a bank loan
Less security required
Widely available
Explain drawbacks of leasing
You don’t own the asset
More expensive than buying it outright
Difficult to cancel the lease
Explain retained profits
Earnings from profitable trading that can be kept in the business or paid out as dividends
Explain benefits of retained profits
Flexibility
Business owner is in control
Low cost
Can be substantial
Explain drawbacks of retained profits
A drain on financing if loss making
Danger of hoarding profits
Opportunity cost for shareholders
Explain debentures
Type of long term loan that only available to PLC’s
What are the two types of debentures
1) the business sells debentures to investors in order to raise finance
2) the debentures can be re-sold to someone else if the investors need their money back
Explain overdraft
A line of credit that lets you have more cash flow to fund capital
Explain the advantages of an overdraft
Useful in an emergency
Quick to take out
Explain disadvantages of an overdraft
Fees can add up quickly
Can damage your credit rating
Explain trade credit
The amount owed to suppliers of a business
Explain hire purchase
A method of paying for an item in instalments
Explain advantages of hire purchase
Cash flow
Fixed interest rate
Immediate access to the money
Explain the drawbacks of hire purchase
Asset depreciation
Ongoing fixed payments
Explain venture capitalists/business angels
Individuals or firms who lend money to the business
Explain the advantages of venture capitalists/business angels
No security necessary
Offers a chance for expansion
Explain the drawbacks of venture capitalists/business angels
Takes a long time to make the decision
The ownership stake is reduced
Explain debt
Finance provided to the business by external parties
Explain equity
Amount invested by the owners of the business
Reasons business have a high amount of debt
Struggle to raise capital
Less equity in the business
Lower interest rates
Strong regular cash flow to pay it back easier
Reasons businesses have a high amount of equity
Harder for the sole trader to obtain a loan
Where there’s greater business risk
Where more flexibility is required
Factors determining a businesses choice of finance
Time - equipment may take several years to pay back
Legal structure
Quantitative factors - have several loans already been applied for
Qualititative factors - taking on a partner increases capital but reduces control
External factors - the economy
Security - less of it lowers the chance of obtaining a loan
Current methods being used to raise finance
Explain fixed costs
Those that don’t change in relation to output
Explain variable costs
A cost which changes as output changes
Explain marginal costs
The additional cost of producing one more unit
Explain average unit cost
The per unit cost of production
Explain revenue
The cash that flows into a business from the sales of goods and services
Explain how to increase revenue
Increase the amount you sell
Achieve a higher selling price
Explain profit
The financial return or reward that entrepreneurs aim to achieve to reflect the risk they take
Explain standard costing
The cost the business expects the production of a product or service to be
Explain actual cost
How much it actually costs and the difference is the variable
Explain cost centres
A specific part of the business where costs can be identified and allocated
How are cost centres allocated
The different products a business produces
Individual departments
Location of different sites
Capital equipment used in different departments
Physical size of the department
Explain advantages of cost centres
Allows you to monitor performance
Motivation of workforce
Look for new suppliers or better production techniques
Explain disadvantages of cost centres
Issues collecting data
Allocation of costs can impact performance
Some costs can be controlled
Could cause conflict because some departments may find it unfair
Explain absorption costing
All indirect costs or overheads are absorbed by different cost centres
explain the usefulness of costing methods to stakeholders
shareholders will look at the bottom line
employees will want to secure a well paid job
managers make business decisions based on costing methods
suppliers will be affected by how much a business is prepared to pay for its supplies
explain profit centres
a separate identifiable part of a business for which its possible to. identify revenues and costs
explain advantages of profit centres
provides insights into where profit is earned
supports budgetary control
can improve motivation
finance can be allocated more efficiently where it makes the best return
explain disadvantages of profit centres
can be time consuming
may lead to conflict and competition within a business potentially de-motivating if profit centres are to tough or unfair cost allocations are made
may pursue their own objectives rather than those of the broader business
explain depreciation
the fall in value of an asset over time
straight line depreciation formula
estimated useful life
reducing balance depreciation formula
net book value x depreciation rate
explain contribution
revenue received from selling a product minus the direct costs of producing that good
total contribution formula
total revenues - total variable costs
contribution per unit formula
selling price per unit - variable costs per unit
breakeven output formula
contribution per unit
explain breakeven analysis
a method of determining the level of sales at which the company will break even
explain margin of safety
the difference between actual output and breakeven output
explain strengths of breakeven
identifies of how long it will take before a start up reaches profitability
helps to understand the viability of a business proposition
helps to determine the margin of safety
shows the importance of controlling costs and setting the correct selling price
explain limitation of breakeven
unrealistic assumptions - price and costs can change
most businesses sell more than one products
should be seen as a planning aid than a decision-making tool
Explain investment appraisal
The process of analysing whether investment projects are worth while
Explain payback period
The time it takes for a project to repay its initial investment
Explain benefits of payback period
Simple calculation
Emphasises speed of return
Straight forward to compare projects
Explain drawbacks of payback period
Ignored cash flow after the payback has been reached
Doesn’t take into account how those value of money changes
Encourages short-term thinking
Simplistic - especially if it’s a big complex investment
Explain average rate of return (ARR)
Looks at the average return for a project to see if it meets the target return
Explain advantages of ARR
Provides a percentage return which can be compared with a target return
Looks at the whole profitability of the project
Focuses on profitability
Explain disadvantages of ARR
Doesn’t take into account cash flows
Takes no account of the time value of money
Threats profits arising late in the project in the same way as those which might arise early
Explain net present value
Calculating the monetary value now of a projects future cash flow
Explain advantages of net present value
Takes account of time value of money, placing emphasis on earlier cash flows
Looks at all the cash flows involved through the life of the project
Use of discounting reduces the impact of long-term less likely cash flows
Has a decision making mechanism
Explain disadvantages of net present value
More complicated method - find it hard to use
Difficult to select the most appropriate discount rate
Doesn’t consider external factors
Explain a businesses budget
A detailed plan for the future concerning the revenues and costs expected over a certain period of time
State what managers use budgets for
Control income and expenditure
Establish priorities
Motivate staff
Improve efficiency
Monitor performance
Explain variance analysis
Involves calculating and investigating the differences between actual results and the budget
Explain causes of favourable variances
Stronger demand than expected
Selling price increases higher than budget
Cautious sales and cost assumptions
Better than expected productivity or efficiency
Explain causes of adverse variances
Unexpected events lead to unbudgeted costs
Over-spends by budget holders
Sales forecasts prove over-optimistic
Market conditions means demand is lower than the budget
Explain zero budgeting
All budgets are set to zero and managers justify and requirements for funds
It helps to prevent a situation where the same money is given each year
Explain flexible budgeting
Allows a business to make allowances for changes in the level of sales
Explain accounting
A process of control on expenditure of a business, and it’s the vehicle for the publication of figures for profit, value and cash
Explain financial accounting
Concentrates with assets, profits and levels of cash within the business, the information is issued in the annual report to satisfy external stakeholders
Explain managerial accounting
Concentrates on internal records allowing the business to monitor and evaluate performance and set targets in order to achieve its objectives
Explain factors affecting the level of working capital
Businesses with a lot of cash sales and few credit sales should have minimal trade debtors
Businesses that trade in completed products will only have finished goods in stock
Some perishable goods have to be sold in a certain time period
Larger businesses may be able to use their bargaining strength as customers to obtain more favourable, extended credit terms from suppliers
Some businesses will receive their monies at certain times of the year
Explain income statements
Shows the profit or loss made by the business - which is the difference between the firms total income and its total costs
Explain revenue
The amount of money generated from sales
Explain costs of sales
The cost of making the goods or buying them
Explain gross profit
Sales minimus direct costs of sales
Explain overheads and expenses
Costs not directly involved in the production process - costs of premises and office costs
Explain operating profit
Gross profit minus overheads
Explain the usefulness of income statement
Progress can be monitored by management and the business can set targets and make decisions
Figures can be used to carry out ratio analysis
Provides other stakeholders with valuable information
Explain a statement of financial position
A snapshot of the business assets and its liabilities on a particular day - usually on the last day of a financial period
Explain assets
What a business owns
Explain liabilities
What a business owes
Using financial accounts to assess business performance
Comparing performance over time - looking at data over years to look for trends
Comparing performance against competitors- how has the business performed against the markets as a whole
Benchmarking against the best - comparison against others who aren’t direct competitors
Explain ratio analysis
The comparison of financial data to gain insights into business performance
What does ratio analysis do
Helps to see why one business is more profitable than other
What returns are being earned in investment in a business
If a business can pay off all its debts
How effectively a business is using its assets
Interpreting gross profit margin
Look for changes from one year to another
A fall in the percentage could suggest higher costs from suppliers or selling at a lower price
A rise in the percentage could suggest better buying from suppliers or selling ar a higher price
Why is return on capital employed (ROCE) useful
Evaluated the overall performance of the business
Provides a target return for individual projects
Benchmarks performance with competitors
Evaluating ROCE
It varies between businesses
It’s based on a snapshot of a businesses balance sheet
Comparisons over time and with key competitors are most useful
Explain liquidity ratios
Liquidity measures the ability to convert assets into cash
About having sufficient cash to keep the business working
Focuses on the ability of a business to have sufficient current liabilities
Explain the current ratio
Measures whether the business can pay debts due within one year out of the current assets
Evaluating current ratio
Ratio of 1.5 to 2 would suggest efficient management of working capital
Ratio below 1 indicates cash problems
High ratio may indicate too much working capital
Industry norms
Trends
Explain the acid test ratio
It’s a more reliable equation because it takes away stock as it may not be turned into cash
>perishable goods have a short shelf life so may not always be sold and turned into cash
Evaluating acid rest ratio
Interpreting results
>a better indicator of liquidity problems for businesses that usually hold inventories
>significantly less than 1 is bad
Less relevant for businesses with high stock turnover
Trend - significant deterioration in the ratio can indicate a liquidity problem
Explain return on equity
Measures the ability of a business to generate profits from its shareholders investments into the business
Explain economies of scale
When unit costs fall as output rises
Explain diseconomies of scale
When unit costs rise as output rises
Explain why businesses grow
Greater profits
Increased market share
More chance of survival
Cost reduction
Explain purchasing eos
Being able to buy in bulk and getting discounts from suppliers
Explain financial eos
Larger businesses have better and more favourable access to sources of finance
Explain managerial eos
Larger businesses can afford to employ the best and most efficient managers
Explain technical eos
Bigger companies being able to acquire expensive technology - advanced machinery
Explain marketing eos
A large firm can spread its advertising and marketing budget to buy it in bulk for cheaper
Explain risk bearing eos
A business can spread risk in different products that a company can fall back on
Explain reasons for diseconomies of scale
Poor communication - more levels in hierarchy or wider spans of control
Lack of motivation - workers can feel isolated
Loss of direction and co-ordination - more difficult for managers to supervise subordinates as they have a wide span of control
Explain solutions to diseconomies of scale
Empowerment - delegation of decision making
Job enrichment - making jobs more interesting
Team working - splitting employees into teams
Explain efficiency ratios
How well the business manages its assets and liabilities
Explain trade receivables (debtors)
amounts owed to a business by customers
Explain trade payables (creditors)
Amounts owed by a business to suppliers and others
Explain receivables days
The average length of time taken by customers to pay amounts owed
Explain payables days
The average length of time taken by a business to pay amounts it owes
Explain asset turnover
Measures how efficiently a business is able to use its net assets to generate sales revenue
The higher the ratio the better as it implies the assets are being used in a more efficient manor to generate sales
Evaluation of asset turnover
A capital intensive business will produce more sales revenue compared to one that doesn’t have any assets, so they’ll have a higher asset turnover
This is why the ratio may be misleading and judged using norms
Explain stock turnover
Measure how quickly a business is turning stock into products that can be sold
Evaluation of stock turnover
A higher number is better
Low numbers suggests problems with stock control
Holding more stock may improve customer service and ability to meet demand
Seasonal fluctuations
It’s irrelevant in some sectors
Explain what the gearing ratio is about
How a business is financed and the relationship between the amount of finance provided by equity and debt
Explain the capital stucture of a business
How the business is finances to enable it to operate over the long-term
Explain equity
Amounts invested by the owners of a business - share capital and retained profits
Explain debt
Finance provided to the business by external parties - bank loans
Evaluation of the gearing ratio
50%+ is seen as high
Less than 20% is seen as low
Level of acceptable gearing depends on the business and the industry
Explain benefits of high gearing
Less capital required to be invested by the shareholders
Debt can be a relatively cheap source of finance compared with dividends
Easy to pay interest if profits and cash flows are strong
Explain benefits of low gearing
Less risk of defaulting on debts
Shareholders rather than debt providers ‘call the shots’
Business has the capacity to add debt if required
Ways to reduce gearing
Focus on profit improvement
Repay on long-term loans
Retain profits rather than pay dividends
Convert loans into equity
Ways to increase gearing
Focus on growth
Convert short-term debt into long-term loans
Buy back ordinary shares
Pay increased dividends out of retained earnings
Issue preference shares or debentures
Explain interest cover
It measures the number of times in which a business can pay its interest charges using its operating profits
Explain shareholders ratios
Measures the returns that shareholders gain from investment
Explain dividend per share
How much dividend received per share
Evaluation of dividend per share
A basic calculation of the return per share
Don’t know how much the shareholder paid for the shares
Don’t know how much profit per share was earned which might have been distributed as a dividend
Explain dividend yields
Dividend per share as a % of the share price
Evaluation of dividend yield
The yield can be compared with other companies in the same sector and rates of return on alternative investments
Shareholders can side dividend yield in deciding whether to invest in the first place
Unusually high yield might suggest an under-valued share price or a possible dividend cut
Dividend yield will change constantly s the share price changes
Explain dividend cover
How many times dividends can be paid from the net profits
Explain price earning ratios
A measure of confidence on what the share will earn
