Accounting And Finance (Chapters 24, 26 - 34, 36, 39) Flashcards
Chapter 24
What is the working capital?
Short-term finance required for the day-to-day running of the business.
Chapter 24
What is meant by ‘short-term finance’?
Short-term finance (working capital) is needed for the day-to-day running of the business and is usually for a period of up to 3 years.
Chapter 24
What factors influence the bank’s decision to lend money to a business?
• What the finance is to be used for.
• The company’s past trading record, or the business proposal if it is a new business.
• The type of product being sold - is it a luxury or a necessity?
• The business’s current financial position, including existing debts.
Chapter 24
What are some short-term sources of finance?
• Overdraft - allows the business to withdraw more money than it has from its current account for an arranged amount.
• Loan - borrows money from a bank with interest.
• Trade credit - a supplier allowing for a delay in payment.
• Factoring - ‘selling debts’ allows the business to gain the majority of the money back at once however, it does lose a percentage of the money owned.
• Hire-purchase - paying for an item in instalments over a period of months or years.
Chapter 24
What is medium-term finance?
Medium-term finance is usually for a period between 3 and 10 years and is mainly used to:
• Expand.
• Replace expensive, broken equipment.
• Convert a business’s persistent overdraft into a formal medium-term loan.
Chapter 24
What are some medium-term sources of finance?
• Medium-term loan - same as any loan however, it is important that a business chooses the interest rate carefully.
• Leasing - paying in instalments for an item but the business doesn’t own it after paying it off (basically it’s like renting it) however, the leasing company has to pay for it to be fixed if it breaks down.
Chapter 24
What is long-term finance?
Long-term finance usually is for a period of time in excess of 10 years.
Chapter 24
What are some long-term sources of finance?
• Long-term loans - used for expensive pieces of machinery.
• Debentures - special loans available only to Plcs which allows them to sell debentures to investors at an annual fixed rate. Can be resold to someone else.
• Issue of shares (equity finance) - only available to companies.
• Retained profit.
• Sales and leaseback - selling off an asset and then leasing it back.
Chapter 24
What are some other sources of finance?
• Government assistance - a business setting up in an ‘assisted area’ becomes eligible for government support (lower taxes, discounts to selling land etc.).
• Depreciation - adding a cost for an asset that loses value over time, meaning a business pays less tax.
• Venture capital - individuals offering money to help a small/medium business to start-up or expand.
• Business angels - provide venture capital and management advice, but might insist on becoming involved in a business to ensure the money is paid back.
Chapter 24
What is the difference between internal and external sources of finance?
Internal sources don’t increase the debts of the business, but are likely to be available to well established businesses. External sources create an additional debt for a business.
Chapter 24
What are some factors that will impact the business’s choice of finance?
• Time (how long to generate profit again).
• Security (lack of security can mean banks are unwilling to lend).
• Legal structure (sole trader, company etc.).
• External influences (state of the economy, competition etc.).
• Quantitative (such as existing levels of debt) and qualitative (such as amount of control desired) factors.
Chapter 24
What are different types of interest that a business can choose?
• Fixed rate - the business has to pay a fixed amount, even if rates fall.
• Variable rate - the business pays interest according to the Bank of England’s decisions on interest rates.
Chapter 26
What are fixed costs?
Costs that do not vary with the level of output.
Chapter 26
What are overhead/indirect costs?
Costs that can’t be attributed to a particular unit of output.
Chapter 26
What are direct costs?
Costs that are directly attributable to a unit output (the raw materials).
Chapter 26
What are variable costs?
Costs that change in proportion to the level of goods/services a business produces.
Chapter 26
What is a marginal cost?
The cost of producing one extra unit.
Chapter 26
What is standard costing?
The cost that the business would normally expect for the production of a particular product, or to complete a particular activity.
Chapter 27
What is contribution per unit and how do you calculate it?
It’s the contribution of each unit of production to the overheads.
Cpu = price - variable costs
Chapter 27
What is the formula for contribution?
Revenue - variable costs
Chapter 28
What is break-even?
The point where total revenue is equal to total costs (TR = TC). At this point all costs have been covered.
Chapter 28
What are some benefits and limitations of break-even analysis?
+ Tables and diagrams showing break-even analysis are easy to understand.
+ Margin of safety can be established.
+ It can be used to show the level of profit at a given level of output.
- Break-even is based on using predicted figures.
- Benefits of economies of scale will affect unit costs.
- There is no certainty all goods will be sold.
Chapter 29
What are the three methods of investment appraisal?
• Payback.
• Accounting rate of return.
• Net present value.
Chapter 29
What is payback as an investment appraisal method and what are some terms used with it?
Payback is a technique that measures how quickly the cost of the investment can be paid back.
Terminology:
• EOY - end of year.
• EOY 0 - the year the investment takes place.
• Net cash inflow.
• Cumulative cash inflow.
Chapter 29
What are some advantages and disadvantages of payback?
+ Easy to calculate and understand, therefore is cost-effective.
+ An effective method for companies in constantly changing markets.
+ Quick and useful guide to the level of risk involved.
- Doesn’t measure the level of profits from the investment.
- Ignores the value of money over time.
- Doesn’t take into consideration any cash inflows after the payback period.
Chapter 29
What is the Accounting Rate of Return (ARR) as an investment appraisal method?
This method measures the profitability of any investment. The profit is expressed as a percentage of the cost of any investment. Also takes into consideration the life of the investment.
Chapter 29
What are some advantages and disadvantages of Accointing Rate of Return?
+ Relatively easy to calculate and understand.
+ Measures the profitability of the investment.
+ Takes into account all the cash inflows throughout the life of the investment.
- Ignores the value of money over time.
- The life of the investment needs to be known and may alter over time.
- Costs more in time and money as it is harder to calculate.
Chapter 29
What is Net Present Value (NPV) as an investment appraisal method?
This method considers the value of money over time. Converts all monetary values into today’s values to allow for a realistic assessment of the returns in the years ahead. Assumes that any inflows will be worth less than the same amount today.
Chapter 29
What are some advantages and disadvantages of Net Present Value?
+ Takes into account the value of money over time.
+ All cash inflows are accounted for.
- More complicated to work out.
- Takes longer calculate and to make decisions and is therefore more expensive.
- It is limited by the selection of the discount factor which is at best only an educated guess.
Chapter 29
What are some non-financial factors affecting investment decisions?
• Resources available, productive capacity, labour, finance.
• The state of the economy.
• The data sources (determine how accurate the forecasts are).
• Personal agenda of the one making the decision.
Chapter 29
What is the Internal Rate of Return?
A method of investment appraisal that uses Net Present Value to calculate the actual return on the investment.
Chapter 29
What is the method for calculating Internal Rate of Return?
It uses 2 discount factors: the first produces a positive NPV, and the second gives a negative NPV. These are used to find the discount factor that produces a NPV of 0.
Chapter 30
What are some reason for a business to do budgeting?
• Providing the basis of control and meeting objectives.
• Ensuring adequate cash flow for day-to-day needs of the business.
• Giving information on the productivity levels of staff and providing means possible means of appraisal and reward for workers.
• Providing information for current and prospective shareholders and investors.
Chapter 30
What is budgeting?
A plan for the future that takes into account the resources available to the business.
Chapter 30
In which budgeting situations is cashflow information useful?
• Need for liquidity (demand for cash inflows).
• Improving liquidity.
• Dealing with bank or other lenders.
• Cashflow can help identify that changes need to be made.
Chapter 30
What are some alternative methods to traditional budgeting?
• Zero budgeting.
• Flexible budgets.
• Variance analysis.
Chapter 30
What is zero budgeting and what are some advantages and disadvantages of it?
• This method involves setting all budgets to zero, requiring managers to justify any requirement for funds.
+ Prevents the same money being given annually, without any consideration.
- It is time consuming to manage such a system and it can be tiresome for the person responsible for it.
Chapter 30
What are flexible budgets?
Involves raising budgets in response to change. E.g. a rise in sales will prompt a rise in costs for raw materials and direct labour. This can be taken into account by increasing the budget.
Chapter 30
What are the 2 types of variance?
• Favourable - if actual sales exceed the budgeted figures (positive variance).
• Adverse - if actual costs exceed the budgeted figures (negative variance).
Chapter 30
What are the features of variance analysis?
• It allows managers to see where there are problems in meeting budgets and where departments are doing particularly well
• In large businesses it won’t be possible for senior managers to analyse and review every budget for the business. Then ‘management by exception’ is used and senior managers are only involved if the variance is particularly favourable or adverse.
Chapter 31
What are cashflow forecasts?
Estimates of the likely inflows and outflows of cash into and out of the business, over a given period of time.
Chapters 31
What are some of the reasons for cashflow forecasts?
• It is useful for business to set its prices.
• Suppliers might want to see it to assess if the business will be able to pay them on time.
• If the forecasted sales are low, promotional pricing can be considered to boost sales revenue.
• Cashflow forecasts are looked at by potential investors to assess the likelihood of success.
Chapter 31
What are some limitations of cashflow forecasts?
• Changes to the interest rates.
• Changes in economic policy.
• Forecasts are only estimates.
• Competitor’s behaviour.
• Changes in technology.
• World events.
Chapter 31
What are some impacts of cashflow forecast and statements on a business?
• They are used as a measure of performance.
• Allow management to correct any problems that may occur.
• Potential lenders can use it to assess viability of business to be able to repay a loan.
Chapter 31
What are some causes of cashflow problems?
• Excess stock (storage costs).
• Change in business environment (ethical, legal factors).
• Late payment from debtors (receivables).
• Paying creditors too quickly.
Chapter 32
What are index numbers and what is the formula used to calculate them?
Index numbers convert values or numbers from different years into a ‘value’ based on one particular year (base year).
Number in year required/number in base year × 100
Chapter 33
What is the income statement?
It reports the level of profit or loss that a business has made in a given period of time (usually one year), often known as the trading or accounting period.
Chapter 33
What are some things contained in an income statement?
• Revenue.
• Costs of sales.
• Gross profit.
• Operating profit.
• Profit before tax.
• Retained profit (profit for the year).
Chapter 33
What are the 3 sectors that the income statement can be divided into and what does each of them consist of?
• Trading account - concentrates on figures used to calculate gross profit (sales revenue and cost of sales).
• Income statement - calculates the operating profit for the business (considers sales revenue, cost of sales and overheads).
• Appropriation account - concentrates on what actually happenes to the profits (shareholder’s dividends, retained profit).
Chapter 33
What is the income statement used for?
• Management can use it to monitor the progress of the business in terms of targets.
• It can be used to calculate particular ratios.
• Investors will see if it’s worth investing in the business.
• Can help the business to help formulate its objectives for the future.
Chapter 34
What is the statement of financial position?
A method of recording the value of wealth of a business at a given moment in time.
Chapter 34
What are the contents of a statement of financial position?
• Non-current assets (buildings).
• Tangible assets (can be seen).
• Intangible assets (not visible e.g. patent, goodwill).
• Current assets (inventory, cash, receivables).
Chapter 34
What are ‘bad debts’ and what are some ways to estimate the likelihood of them?
‘Bad debts’ means the debts which won’t be paid off. The methods are used to calculate the realisric figure for the trade receivables:
• Allowance method - using an average percentage of bad debts.
• Ageing method - the longer the account is overdue, the bigger the likelihood.
• Credit sales -
