✓Accounting And Finance (Chapters 24, 26 - 34, 36, 39)

Question 1

Chapter 24
What is the working capital?

Answer 1

Short-term finance required for the day-to-day running of the business.

Question 2

Chapter 24
What is meant by ‘short-term finance’?

Answer 2

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.

Question 3

Chapter 24
What factors influence the bank’s decision to lend money to a business?

Answer 3

• 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.

Question 4

Chapter 24
What are some short-term sources of finance?

Answer 4

• 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.

Question 5

Chapter 24
What is medium-term finance?

Answer 5

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.

Question 6

Chapter 24
What are some medium-term sources of finance?

Answer 6

• 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.

Question 7

Chapter 24
What is long-term finance?

Answer 7

Long-term finance usually is for a period of time in excess of 10 years.

Question 8

Chapter 24
What are some long-term sources of finance?

Answer 8

• 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.

Question 9

Chapter 24
What are some other sources of finance?

Answer 9

• 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.

Question 10

Chapter 24
What is the difference between internal and external sources of finance?

Answer 10

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.

Question 11

Chapter 24
What are some factors that will impact the business’s choice of finance?

Answer 11

• 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.

Question 12

Chapter 24
What are different types of interest that a business can choose?

Answer 12

• 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.

Question 13

Chapter 26
What are fixed costs?

Answer 13

Costs that do not vary with the level of output.

Question 14

Chapter 26
What are overhead/indirect costs?

Answer 14

Costs that can’t be attributed to a particular unit of output.

Question 15

Chapter 26
What are direct costs?

Answer 15

Costs that are directly attributable to a unit output (the raw materials).

Question 16

Chapter 26
What are variable costs?

Answer 16

Costs that change in proportion to the level of goods/services a business produces.

Question 17

Chapter 26
What is a marginal cost?

Answer 17

The cost of producing one extra unit.

Question 18

Chapter 26
What is standard costing?

Answer 18

The cost that the business would normally expect for the production of a particular product, or to complete a particular activity.

Question 19

Chapter 27
What is contribution per unit and how do you calculate it?

Answer 19

It’s the contribution of each unit of production to the overheads.
Cpu = price - variable costs

Question 20

Chapter 27
What is the formula for contribution?

Answer 20

Revenue - variable costs

Question 21

Chapter 28
What is break-even?

Answer 21

The point where total revenue is equal to total costs (TR = TC). At this point all costs have been covered.

Question 22

Chapter 28
What are some benefits and limitations of break-even analysis?

Answer 22

+ 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.

Question 23

Chapter 29
What are the three methods of investment appraisal?

Answer 23

• Payback.
• Accounting rate of return.
• Net present value.

Question 24

Chapter 29
What is payback as an investment appraisal method and what are some terms used with it?

Answer 24

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.

Question 25

Chapter 29 What are some advantages and disadvantages of payback?

Answer 25

+ 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.

Question 26

Chapter 29 What is the Accounting Rate of Return (ARR) as an investment appraisal method?

Answer 26

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.

Question 27

Chapter 29 What are some advantages and disadvantages of Accointing Rate of Return?

Answer 27

+ 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.

Question 28

Chapter 29 What is Net Present Value (NPV) as an investment appraisal method?

Answer 28

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.

Question 29

Chapter 29 What are some advantages and disadvantages of Net Present Value?

Answer 29

+ 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.

Question 30

Chapter 29 What are some non-financial factors affecting investment decisions?

Answer 30

• 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.

Question 31

Chapter 29 What is the Internal Rate of Return?

Answer 31

A method of investment appraisal that uses Net Present Value to calculate the actual return on the investment.

Question 32

Chapter 29 What is the method for calculating Internal Rate of Return?

Answer 32

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.

Question 33

Chapter 30 What are some reason for a business to do budgeting?

Answer 33

• 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.

Question 34

Chapter 30 What is budgeting?

Answer 34

A plan for the future that takes into account the resources available to the business.

Question 35

Chapter 30 In which budgeting situations is cashflow information useful?

Answer 35

• 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.

Question 36

Chapter 30 What are some alternative methods to traditional budgeting?

Answer 36

• Zero budgeting. • Flexible budgets. • Variance analysis.

Question 37

Chapter 30 What is zero budgeting and what are some advantages and disadvantages of it?

Answer 37

• 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.

Question 38

Chapter 30 What are flexible budgets?

Answer 38

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.

Question 39

Chapter 30 What are the 2 types of variance?

Answer 39

• Favourable - if actual sales exceed the budgeted figures (positive variance). • Adverse - if actual costs exceed the budgeted figures (negative variance).

Question 40

Chapter 30 What are the features of variance analysis?

Answer 40

• 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.

Question 41

Chapter 31 What are cashflow forecasts?

Answer 41

Estimates of the likely inflows and outflows of cash into and out of the business, over a given period of time.

Question 42

Chapters 31 What are some of the reasons for cashflow forecasts?

Answer 42

• 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.

Question 43

Chapter 31 What are some limitations of cashflow forecasts?

Answer 43

• Changes to the interest rates. • Changes in economic policy. • Forecasts are only estimates. • Competitor's behaviour. • Changes in technology. • World events.

Question 44

Chapter 31 What are some impacts of cashflow forecast and statements on a business?

Answer 44

• 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.

Question 45

Chapter 31 What are some causes of cashflow problems?

Answer 45

• Excess stock (storage costs). • Change in business environment (ethical, legal factors). • Late payment from debtors (receivables). • Paying creditors too quickly.

Question 46

Chapter 32 What are index numbers and what is the formula used to calculate them?

Answer 46

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

Question 47

Chapter 33 What is the income statement?

Answer 47

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.

Question 48

Chapter 33 What are some things contained in an income statement?

Answer 48

• Revenue. • Costs of sales. • Gross profit. • Operating profit. • Profit before tax. • Retained profit (profit for the year).

Question 49

Chapter 33 What are the 3 sectors that the income statement can be divided into and what does each of them consist of?

Answer 49

• 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).

Question 50

Chapter 33 What is the income statement used for?

Answer 50

• 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.

Question 51

Chapter 34 What is the statement of financial position?

Answer 51

A method of recording the value of wealth of a business at a given moment in time.

Question 52

Chapter 34 What are the contents of a statement of financial position?

Answer 52

• Non-current assets (buildings). • Tangible assets (can be seen). • Intangible assets (not visible e.g. patent, goodwill). • Current assets (inventory, cash, receivables).

Question 53

Chapter 34 What are 'bad debts' and what are some ways to estimate the likelihood of them?

Answer 53

'Bad debts' means the debts which won't be paid off. The methods are used to calculate the realistic 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 - using previous records of the business regarding bad debts.

Question 54

Chapter 34 What is liquidity for a business?

Answer 54

The ability to convert assets into cash.

Question 55

Chapter 34 What are liabilities for a business and what are some examples of them?

Answer 55

Liabilities are what a business owes (negatives on the statement of financial position). Some examples are: • Overdraft. • Long-term liabilities (mortgage, bank loan). • Net current assets (working capital).

Question 56

Chapter 34 What are the two different types of shares?

Answer 56

• Ordinary shares. • Preference shares (prioritised over ordinary shares).

Question 57

Chapter 34 What is the statement of financial position useful for?

Answer 57

• Useful if the business wants to obtain a loan from a bank (allows the bank to assess if it has enough assets for security). • Useful to assess if the business has enough cash to keep itself afloat.

Question 58

Chapter 36 What is ratio analysis?

Answer 58

A method of measuring the performance of a business from various perspectives for the benefit of a range of stakeholders of the business.

Question 59

Chapter 36 What are the different types of ratio and what is each of them concerned with?

Answer 59

• Liquidity - can the business cover its short-term liabilities? • Profitability - how profitable it is in relation to sales/assets/capital invested. • Financial efficiency - how efficient it is at moving stock or collecting/paying owed money. • Shareholder - how the shareholders' investments are performing compared to alternatives. • Gearing - how able it is at borrowing money and covering said cost (long-term liabilities).

Question 60

Chapter 36 What are some benefits and limitations of ratios?

Answer 60

+ Stakeholders and suppliers/creditors can use them to assess if the business is worth/safe to trade with. + Management can use certain ratios as a measure of performance. + Employees can use them to ascertain if their jobs are secure. - It's assumed that figures used are calculated in the same way each time for comparisons to be made. - Inflation may distort figures such as profit and revenue. - State of the economy may mean that a fall in certain ratios isn't the fault of the business.

Question 61

Chapter 39 Which ratios are included in the profitability ratios?

Answer 61

• Gross profit margin. • Net profit margin. • Return On Capital Employed (ROCE). • Return On Equity (ROE).

Question 62

Chapter 39 What is the difference between Return On Equity and Return On Capital Employed?

Answer 62

ROE considers the amount of profit generated from sales and ROCE takes into consideration all sources of capital employed within a business (shareholders' funds and loans).