Accounting and Finance Flashcards
1
Q
What might a business invest finance in?
A
- Purchasing machinery
- Extending the factory
- Investing in a marketing campaign
- Growth
- Advertisement
2
Q
What are 2 ways of working out the returns of investments?
A
- Payback charts
2. Average Rate of Return (ARR %)
3
Q
What is an advantage and disadvantage of using payback to determine returns on investments?
A
An advantage is that it is simple and easy to calculate, which will mean quicker decision making.
A disadvantage is that it is based on assumptions and doesn’t account for external influences so may not always be accurate
4
Q
How do you work out ARR?
A
- Add up all cash inflows
- Subtract from cost of investment (profit)
- Profit / Years of investment
- = ARR
ARR
——– x 100 = Profit (%)
Initial Investment
5
Q
What is are the advantages of using ARR to determine returns on investments?
A
- % return can be compared with a target return
- Focuses on profitability, key issue for shareholders
6
Q
What is are the disadvantages of using ARR to determine returns on investments?
A
- Does not take into account cash flows, only profit
- Takes no account of inflation, or the value of money
- Assumes early profits are as important as late profits
7
Q
What is ROCE?
A
Return on Capital Investment
8
Q
What does ROCE do?
A
Tells us what returns/profits the business has made on the resources available to it
9
Q
What is the formula for ROCE?
A
ROCE (%) = Operating Profit/Capital Employed x 100
10
Q
What is capital employed?
A
All funds invested added together
E.g, Share capital + Retained Profit + Loan borrowings
11
Q
What is meant by an internal source of finance?
A
Money sourced from within the business
12
Q
What are some examples of internal sources of finance?
A
- Divestment
- Personal savings
- Sale/lease back
- Factoring
- Retained profits
- Sale of fixed assets
13
Q
What is meant by divestment?
A
Close down/stop a certain part of the business or investment. Use this money a source of finance for something else. It is a long term source.
14
Q
What is sale/lease back?
A
Selling your own property to be able to raise finance for investment, and then leasing the property back off the new owner. It is a medium term source.
15
Q
What is factoring?
A
Selling your debt. It is a short term source.
16
Q
What are retained profits?
A
Profits made by the business which are saved to be reinvested back into the business. It is a medium term source.
17
Q
What is sale of fixed assets?
A
Sale of business assets which are unused or not necessary, in order to generate more finance. It is a long term source.
18
Q
What are the 3 types of financial investment?
A
- Short term (up to 3 years)
- Medium term (3-10 years)
- Long term (10+ years)
19
Q
What factors need to be considered when choosing a source of finance?
A
- Expensive or cheap?
- Easy or hard to obtain?
- Opportunity cost
- Is this option available and accessible?
20
Q
What are the advantages of personal savings?
A
- Cheap for the business
- Easily available
21
Q
What are the disadvantages of personal savings?
A
- Might take a while to save enough
- Personal risk
- Opportunity cost
22
Q
What are the advantages of sale/lease back?
A
- Asset can still be used
- High finance obtained from sale
23
Q
What are the disadvantages of sale/lease back?
A
- Only short term gain, might not be able to leaseback over a long period of time
- Expensive over time, cost builds up
24
Q
What are the advantages of factoring?
A
- Obtain finance quickly
- Saves time and inconvenience
25
What are the disadvantages of factoring?
- Expensive, they take of portion of it (debt collection)
| - May cause resentment
26
What are the advantages of retained profit?
- Easy to obtain
- Cheap source of finance
- No loan/debt/lease to pay off
27
What are the disadvantages of retained profit?
- Might be hard to obtain enough profit to fulfil the investment
- Opportunity cost, no savings interest
- May not be available
- Can't pay dividends
28
What are the advantages of sale of fixed assets?
- Cheap, quick, easy money
| - Get rid of unnecessary expenses
29
What are the advantages of divestment?
- Can be reinvested into something more profitable
- Allows specialisation
- Efficient
30
What are the disadvantages of divestment?
- Opportunity cost
| - loss of staff and redundancy pay
31
What are external sources of finance?
Sourcing money from outside of the business
32
What is an overdraft?
Withdrawing over the limit of your bank account (going into minus) - short term
33
What is trade credit?
Paying for stock/materials after a period of time (usually 30 days) giving time for finance to be raised from sales first - short term
34
What is leasing?
A legal agreement where you pay for a right to use an asset which is owned by someone else, effectively renting - short/medium term
35
What is hire purchase?
Hiring assets (cars, equipment etc.), they do not become property of the user until a final bloom payment has been made
36
What is a bank loan?
Borrowing money from the bank and paying it off with interest - long term
37
What is a grant?
Money from the government which is given to a business for a specific purpose - medium term
38
What is a share issue?
Only used by limited companies (plc/ltd), finance is raised in return for a share in the business - long term
39
What is a mortgage?
A legal agreement where a bank/building society lends money at interest in exchange for ownership of property. - long term
40
What is a venture capital?
Investment made by specialist or another business - medium term
41
What are the advantages of an overdraft?
- Quick access
| - Cheaper than other sources
42
What are the disadvantages of an overdraft?
- Has to be repaid, usually w interest
| - Bank can reduce overdraft limit
43
What are the advantages of trade credit?
- Helps cash flow
- No interest costs
- Flexibility w repayment
44
What are the disadvantages of trade credit?
- Problem if stock doesn't sell
- Bargain power lowered
- Risk losing supplier if not able to repay
45
What are the advantages of a grant?
- Interest free
- No repayment/debt
- Helps start up investment
46
What are the disadvantages of a grant?
- Has to be for a specific purpose
- May not get full amount required
- Loss of flexibility, slow to access
47
What are the advantages of a share issue?
- High finance raised
| - Publicity
48
What are the disadvantages of a share issue?
- Loss of control
- More dividend payments
- Expensive
49
What are the advantages of leasing?
- Product readily available
- More flexibility
- Cheaper than buying outright
50
What are the disadvantages of leasing?
- No ownership/expensive longterm
| - Cannot be used to raise finance in future
51
What are the advantages of having a loan/mortgage?
- Repayment can be spread over time and paid in instalments
- Ownership of property (mortgage)
- Usually large amount of capital obtained
52
What are the disadvantages of having a loan/mortgage?
- Interest to be paid with repayment
- Bank may not always give out loans if credit history is bad or weak
- The bank hang on to the deeds of your property as security
53
What are the advantages of venture capital?
- High finance raised
54
What are the disadvantages of venture capital?
- hard to access
| - take a % of profits in return
55
State the principles of accounting
- Consistency in methodology
- Going concern (running normally)
- Matching - all accounts are done at the same time
- Materiality - realistic calculations
- Objecitivity - removes bias and subjectivity
- Prudence, being careful, perhaps undervalue
- Realisation, published at the same time
56
What is an income statement?
A financial document that shows the income and expenditure over the course of a 12 month period. It may also be known as a profit/loss account
57
What items are included in an income statement?
- Sales revenue
- Cost of producing of sales
- Gross profit
- Overheads and expenses, costs not directly involved in the production process such as rent
- Net profit
58
What is a debenture?
An agreement between the lender and the borrower which is issued by the company. It typically carries a fixed rate or interest over the course of the loan. it is a long term source of finance/loan which is predominantly aimed at big company
59
What are the quantitative factors surrounding methods of finance?
- How much debt do we already have?
| - How expensive is this source of finance?
60
What are the qualititative factors surrounding methods of finance?
- Do we remain in control of the business and the finance?
| e. g) venture capital, share issue
61
What is a budget and why is it necessary?
A budget involves allocating a set amount of money each month for various expenses. It is a necessary to limit costs and keep spending under control
62
What is variance?
The difference between planned budgets and the actual spending outcome, e.g) whether a business was under or over budget
63
What are the 2 types of variance?
Positive variance = underbudget
| Negative variance = overbudget
64
What is meant by a gearing ratio?
A ratio that is the percentage that shows how much of the investment business has to pay back
65
What is the formula for calculating gearing ratio?
Long term liabilities/Capital employed x100
66
What does it mean if a businesses gearing ratio is over 50%?
If it is over 50%, the business is said to be highly geared. Ideally, a business should aim for low gearing
67
What is meant by interest cover?
A figure that compares interest payments with profits and assess' risk
68
What is the purpose of interest cover?
To see if interest payments can be covered with profits
69
What is the formula for calculating interest cover?
Profit before tax and interest (operating profit)/Interest
70
What is meant by the gross profit margin?
GPM is a profitability ratio that shows the % profit made per item/unit of output
71
How do you calculate the gross profit margin?
Gross Profit/Sales Revenue x 100
72
What is meant by the net profit margin?
NPM is a profitability ratio that shows the % profit made per item/unit of output with production costs deducted. This is the profit a business keeps
73
What is meant by the net profit margin?
Net profit (before tax)/Sales Revenue x 100
74
What is cash flow forecasting?
Estimating/forecasting the money that flows in and out of a business
75
How can cash flow concerns be addressed?
- Boost prices to bring in more revenue
- Launch a new desirable product
- Reduce wage bill by giving less hours for overtime
- Pay expenses such as insurance on a monthly basis to manage outflows
76
Explain how producing a cash flow forecast helps when applying for a bank loan
It might be helpful because the bank can see the management of income and expenses over a 12 month period from which they can make a judgement of how much risk there is providing a bank loan and how well they can pay off overdraft credit
77
What are the benefits of cash flow forecasting?
- Helps set targets for management
- Helps see cash flow which is vital for survival
- Spots problems in advance which allows solutions to be put in place
78
What are the limitations of cash flow forecasting?
- only an estimate, may not be accurate
| - Doesn't show the liquid position of the business
79
What is return of equity?
How much profit is made per £ of shares. A higher figure is more desirable for the business
80
Why do businesses use efficiency ratios?
To see how well the business manages its assets and liabilities
81
What is meant by asset turnover?
How much revenue assets are generating
82
What is the formula for calculating the net asset turnover?
Sales Revenue/Net assets
83
What is the formula for calculating the non current asset turnover?
Sales Revenue/Non current assets
84
What is the formula for calculating stock turnover?
Cost of sales/Average stock held
85
How would you interpret figures for stock turnover?
- Higher number is better
| - Low number suggests problem with stock control
86
How do you calculate dividend per share (£)?
Total dividends paid/Number of shares
87
How do you calculate dividend yield?
Dividend per share(pence)/Share price(pence)
88
How do you calculate earnings per share?
Profit for the year/No. of shares issued
89
How do you calculate price earnings ratio?
Market price of share/Earnings per share
90
What does ARR measure?
ARR measures the average profit gained as a % of the cost of the investment
91
What are the steps for working out ARR?
1. Calculate total profits (Rev-Costs)
2. Total profit/Lifetime of investment (5 years) = AV profit
3. (AVP/Cost of investment) x 100
92
What are 4 examples of profitability ratios?
1. ROCE
2. Gross profit margin
3. Net profit margin
4. Return on equity
93
How do you calculate return on equity?
Net profit/equity x 100
94
What are 4 examples of activity ratios?
1. Asset turnover
2. Stock turnover
3. Debtor collection period
4. Creditor payment
95
How do you calculate the debtor collection period?
Debtors/Turnover x 365
96
How do you calculate creditor payment?
Creditors/Cost of sales x 365
97
What are 4 examples of liquidity ratios?
1. Current ratio
2. Acid test ratio
3. Gearing ratio
4. Interest cover
98
What are 4 examples of shareholder ratios?
1. Earnings per share
2. Price earnings ratio
3. Dividend per share
4. Dividend yield
99
How do you calculate dividend cover?
Profit after tax/Dividends
100
What is dividend cover?
How many times dividends can be paid from net profits
101
What is meant by working capital?
The capital of a business which is used in its daily operations, the money that is currently available to a business for purchasing stock, paying wages & rent etc.
102
How do you calculate working capital?
Current Assets - current liabilities
103
What is the working capital cycle?
The amount of time it takes to turn working capital into actual cash
104
What does a long working capital cycle mean for a business?
The longer the cycle is, the longer a business is tying up capital without earning a return to it
105
What is the formula for calculating the working capital cycle?
Working capital x 365 / Sales Revenue
106
What are some examples of fixed/non current assets?
- Factory
- Furniture
- Delivery van
- Machinery
- Land
107
What are some examples of current assets?
- Cash in the till
| - Stock
108
What are some examples of long term/non current liabilities?
- Mortgage
| - Loan over 10 years
109
What are some examples of short term/current liabilities?
- Payment owed for stock on trade credit
- Electric/gas bill payments
- Overdraft
110
What is depreciation?
A reduction in the value of an asset over time
111
What is the difference between straight line depreciation and percentage depreciation?
Straight line is when the asset reduces by a set value every year (simple) whereas percentage is when the asset reduces by a set percentage every year (compound)
112
What is net book value?
The value of the asset once depreciation has been taken into account
113
What is residual value?
The end of lifetime value post depreciation
114
acid test ratio formula
(current assets-stock) / liabilities
115
ROCE formula
operating profit / capital employed x 100
116
What are the 2 main types of accounting?
1. Financial accounting
| 2. Management accounting
117
What is meant by financial accounting, and what is its main purpose?
Concentrates on the assets, profits and levels of cash within the business. The main purpose is to satisfy the external stakeholders of a business, such as shareholders and financial institutions.
118
What is meant by management accounting, and what does it enable a business to do?
Concentrates on the internal financial accounts, allowing the business to monitor and evaluate performance. It enables the business to set targets and therefore achieve its objective
119
What are accounting principles for?
- 7 principles that are put in place to ensure that figures are produced in a standardised manner
- All these principles are guides which exist in order for stakeholders to view the accounts with confidence and trust
120
What is the consistency principle?
- All accounts produced in the same way
| - Businesses will have a policy for the formulation of accounts and will apply this consistently
121
What are the advantages of break even?
- Helps set targets
- Help to monitor success of the business
- Identifies whether products are a waste of time
- Helps justification for loans and borrowing money
122
What are the disadvantages of break even?
- Fixed costs may unexpectedly change
- It is only a prediction
- Assumes all output is sold
123
What is break even formula?
Fixed costs/(selling price-variable costs)
124
What is the margin of safety?
The difference between the number of products sold and the break even point
125
What is a profit centre?
A separately identifiable part of a business for which it is possible to identify revenues and costs
126
What are the advantages of profit centres?
- Identifies where profit is earned
- Support budgetary control
- Comparisons can be made
- Finance can be allocated more efficiently
127
What are the disadvantages of profit centres?
- Can be time consuming to set up and monitor
- May lead to conflict and competition within the business
- Potentially demotivating if profit centre targets are unattainable
128
What is a cost centre?
A department for which costs can be solely calculated
129
What are the 2 types of costing?
```
Absorption costing (split into %)
Full costing (shared equally amongst all products)
```
130
State 4 possible financial objectives
1. Good cash flow
2. Maintain a high share price
3. Maximise profits and dividends
4. Retaining profits and saving money
131
What are some internal factors that might influence whether a business can meet its financial objectives or not?
- Corporate objectives
- Existing debt
- Management ambition
132
What are some external factors that might influence whether a business can meet its financial objectives or not?
- Competition
- Interest rates
- STEEPLE
133
Current Ratio
current assets / current liabilities
134
Payback
cost of investments / cash inflows
