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LC Business Studies > Accounting Chap 11 > Flashcards

Accounting Chap 11 Flashcards

1
Q

Name two types of financial statement

A

Trading, Profit and Loss Account

Balance Sheet

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2
Q

Explain the P and L account

A

The P&L A/C calculates the amount of profit (or loss) that the business makes in a year.
Two parts:
The Trading Account – calculates Gross Profit (before expenses)
The Profit and Loss Account – calculates Net Profit (after expenses)

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3
Q

Explain sales

A

How much money the business sold its products for.

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4
Q

Explain Cost of Sales

A

Shows how much the business spent making or buying the goods they sold.

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5
Q

Explain Gross Profit

A

Shows the profit made by the business before they take into account any other expenses.

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6
Q

What is the formula for gross profit?

A

Sales – Cost of Sales = Gross Profit

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7
Q

Explain expenses

A

Shows the total of all the expenses of a business over that year e.g light and heat, rent, wages

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8
Q

Explain Net profit

A

Shows the profit made by the business after all the expenses have been paid.

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9
Q

What is the formula for Net Profit?

A

Net Profit = Gross Profit – Expenses

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10
Q

Explain Balance Sheet

A

A balance sheet shows a business’s financial position (its wealth) at a certain period of time
It shows the company’s Assets and Liabilities and how the company is financed.

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11
Q

Explain fixed assets

A

These are all the valuable items that a business owns that will last for longer than a year e.g buildings, vans, machinery

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12
Q

Explain Current Assets

A

These are all the valuable items a business owns that will be kept for less than one year e.g cash at bank, stock, debtors

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13
Q

Explain Current Liability

A

These are items that a business owes and must pay within one year e.g bank overdraft, creditors

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14
Q

Explain working capital

A

This the cash left over in business for it to pay its bills.

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15
Q

What is the formula for working capital?

A

Working Capital = Current Assets – Current Liabilities

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16
Q

Explain Financed By

A

This shows the amount of money invested in the business e.g shares, long-term loans

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17
Q

Explain Ordinary Share Capital (Equity Share Capital)

A

the amount of money paid into the business by shareholders

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18
Q

Explain authorised share capital

A

The maximum value of shares that can be issued in the business by way of share capital

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19
Q

Explain retained earnings (reserves)

A

shows the total amount of profit that has been reinvested into the business.

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20
Q

Explain preference shares

A

Another type of investment in a company. Preference shares are guaranteed a dividend at the end of each year and come before other shareholders for payment

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21
Q

Explain long-term loans

A

Money that the company has borrowed that are repaid over a number of years.

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22
Q

What are the three main headings of ratio analysis

A

Profitability
Liquidity
Gearing or Debt/Equity Ratio

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23
Q

What is the formula for gross profit percentage (gross profit margin)

A

Gross profit/sales x 100 = %

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24
Q

What is the formula for net profit percentage (net profit margin)

A

Net profit/sales x 100 = %

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25
Q

What is the formula for return on investment or return on capital employed

A

Net Profit/ Capital Employed x 100 = %

26
Q

What is the formula for capital employed

A

Capital employed=Ordinary Share Capital =Retained Earnings (reserves)+Long term loans + preference shares

27
Q

Who is interested in a business’s profitability ratios?

A 
Investors / Shareholders
Employees
Lenders / Banks
Government
Other Businesses-Competition
28
Q

Explain liquidity

A

Liquidity examines whether the business has enough cash available to pay its short term bills (current liabilities) e.g light & heat, rent, wages

29
Q

Name two liquidity ratios

A

Working Capital Ratio (Current Ratio)

Acid Test Ratio

30
Q

What is the formula for working capital (Current Ratio)

A

CA/CL = x:1

31
Q

What is the ideal current ratio for business

A

Ideal ratio 2:1 (business is said to be liquid)
If ratio is below this business is illiquid and does not enough money to pay bills as they fall due
If ratio is much higher business has excess cash and should invest it into other areas

32
Q

What is the purpose of the Acid test ratio?

A

Investigates if company has emergency cash to pay bills straight away

33
Q

What is acid test ratio formula?

A

CA- Closing stock/ CL = x:1

34
Q

What is ideal ratio for acid test ratio?

A

1:1

35
Q

Why is closing stock excluded for acid test ratio

A

It is the hardest asset to turn quickly into cash

36
Q

Who looks at a firm’s liquidity ratios?

A

Suppliers
Employees
Lenders / Banks
Government

37
Q

Who looks at a firm’s Debt/Equity ratios

A 
Investors / Shareholders
Employees
Lenders (Banks)
Suppliers
Government
38
Q

What are the limitations of ratios?

A

Historical figures- shows what happened in past. Not true indicators f what will happen in future
Difference in calculation of accounting figures- change it’s method and comparing ratios may not be accurate
Limited picture- only show financial information

39
Q

What is the debt/equity ratio formula

A

(Long-term debt (loans) + Pref Shares) / (Ordinary hare capital + retained earnings(reserves)) = X:1

40
Q

What is the gearing of a firm if they have less debt capital than equity capital

A

low gearing

41
Q

What is the gearing of a firm if they have more debt capital than equity capital

A

high gearing

42
Q

What is the gearing of a firm if they have equal debt capital to equity capital

A

neutral gearing

43
Q

If firm is low gearing with ratio answer be greater than or less than one

A

less than

44
Q

If firm is high gearing with ratio answer be greater than or less than one

A

greater than

45
Q

Discuss the trend if the gross profit percentage increases from one year to the next

A

This is a good trend as business is making relatively more gross profit than least year.
Either business increased selling price or now pays less to make/buy products

46
Q

Discuss the trend if the gross profit percentage decreases from one year to the next

A

This is a bad trend as business if making relatively less gross profit than last year.
Cause- Selling price business gets for products decreased and/or cost they pay for them increased
Business should shop for cheaper supplier so GP margin will increase next year

47
Q

Discuss the trend if the net profit percentage increases from one year to the next

A

This is a good trend as business is making relatively more net profit than least year.
Business expenses decreased

48
Q

Discuss the trend if the net profit percentage decreases from one year to the next

A

This is a bad trend as business if making relatively less net profit than last year.
Business expenses must have increased
Business can make cuts to expenses immediately by asking worker to take voluntary pay cuts

49
Q

Discuss the trend if the Return on investment increases from one year to the next

A

Good trend as business is making better return than last year for shareholders
Managers improved their performance over year
They made more money from business’s resources than last year

50
Q

Discuss the trend if the Return on investment decreases from one year to the next

A

Bad trend as business is making lower return for shareholders than last year
Reason- net profit didn’t increase in line with capital invested in business
Owners should consider replacing directors - better able to manage resources and generate profit
Need to reduce capital employed or increase net profit with cost cutting measures ex: voluntary pay cuts
ROCE for both years higher than return on risk free investments? 1/2% approx

51
Q

Why are investors/shareholders interested in profitability ratios

A

Improving then more likely to receive dividends and so more likely to invest in business
ROI- interest as will compare with returns available from other investment opportunities

52
Q

Why are lenders/bank interested in profitability ratios

A

improving then business sis more likely to be able to repay interest on loan

53
Q

Discuss trend if current ratio decreases from one year to next

A

Bad trend as business has relatively less cash available to pay it’s bills than last year
Compare to ideal ratio 2:1 both years. If below business does not have enough cash to pay bills- illiquid
Cause- Business increased overdraft? and spent all the money
Could lead to creditors cutting off business’s credit
Business could sell investments to raise cash and improve liquidity

54
Q

Discuss trend if current ratio increases from one year to next

A

Good trend as business has more cash than last year available to pay bills
May have paid off some of it’s bank overdraft
Compare to ideal ratio 2:1 - if below business does not have enough cash to pay bills- illiquid
Business should have twice amount that it owes

55
Q

Discuss trend if acid test ratio increases from one year to the next

A

Good trend as business has more cash available to pay bills than last year
May have paid off some of it’s bank overdraft
Compare to 1:1- if below business does not have enough cash to pay bills- illiquid
Cash is not tied up in stock

56
Q

Discuss trend if acid test ratio decreases from one year to the next

A

Bad trend as business has relatively less cash available to pay it’s bills than last year
Compare to ideal ratio 1:1 both years. If below business does not have enough cash to pay bills- illiquid
Cause- Business stock levels increased? - cash tied up in stock
Could lead to creditors cutting off business’s credit
Business could have sale to get rid of some stock and raise cash to bring ratio back to 1:1

57
Q

Explain why Lenders/Banks and Suppliers are interested in a business’s liquidity ratios

A

Lender- Improving means business more likely to repay loan and interest on it in full on time
Supplier- Improving business is more likely to pay invoice full and on time

58
Q

Discuss trend if debt/equity ratio decreases from one year to the next

A

Good trend as business has relatively less long-term debt outstanding than last year
High/Low geared
Business may have paid back some of loan or sold more shares in business
Business should continue this strategy

59
Q

Discuss trend if debt/equity ratio increases from one year to the next

A

Bad trend as business has relatively more long-term debt outstanding than last year
Business increased long-term loans and increased levels of borrowing mean more interest to repay.
Higher chance of bankruptcy
Business should reinvest more profit o sell more shares to get money and pay off loans

60
Q

Why are investors/shareholders interested in debt/equity ratio

A

Increasing- more profits being used to pay interest and means fewer dividends for investors. Investors will be less likely to buy shares

61
Q

Why are lenders/banks interested in debt/equity ratio

A

decreasing then business is likely to be able to repay loan and interest on time and in full

LC Business Studies (28 decks)

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