Chapter 10: Financial function

Question 1

What is Triple bottom line reporting?

Answer 1

Triple bottom line reporting (also known as Integrated
reporting) requires the business to look at the following three Issues when reporting on how well the business has performed:

People
Planet
Profit

Question 2

What is the Statement of Comprehensive Income?

Answer 2

The Statement of Comprehensive Income is
used to calculate the net profit of the business for the financial year.

All income - all expenses = net profit.

If it is a Sole Trader or Partnership, the business will not pay tax as the owner pays
tax in his/her personal capacity.

There is, therefore, no indication of tax on the
Statement of Comprehensive Income

Question 3

What is the Statement of Financial Position?

Answer 3

The Statement of Financial Position shows all Assets, Owner’s Equity and Liabilities of the business.

The Statement of Financial Position should always balance:
The reason why the Statement of Financial Position should balance is that there are only two options for a business to obtain capital:
Own money
Borrowed money

If the business wants to purchase assets, it has to use its own or borrowed capital. This means: Total Assets = Owner’s Equity + Total Liabilities.

Question 4

Own vs Borrowed capital:

Answer 4

Own capital: Is an investment made by the owner of the business

Borrowed capital / foreign capital: Any money that the business borrows creates a liability for the business.

Question 5

Factors to consider when deciding between own vs. borrowed capital:

The finance period and the nature of the assets bought:

Answer 5

Capital obtained from issuing shares is permanent, but borrowed capital must be
repaid within a specific period. If long-term finance is required.

Long-term assets should maybe be financed using own capital.

Question 6

Control:

Answer 6

Banks and creditors do not have a say in the management of the company.

Question 6

Urgency:

Answer 6

It is a relatively fast process to obtain a loan. Most banks will give an answer within maybe a week.

Question 7

Solvency:

Answer 7

To determine if a business is solvent, we will look at the Solvency ratio Solvent = assets > liabilities.

Insolvent/bankrupt = assets <liabilities.

When the ratio between assets and liabilities is low, it is better to sell shares rather than take
out a loan that may bring the solvency of the business in jeopardy.

Question 8

Long-term capital:

Long-term capital is also known as Fixed Capital.

Answer 8

The most common source of long-capital is selling shares (own capital), while the most
common form of long-term borrowed capital is a loan from the bank.

Question 9

Short-term capital:

Answer 9

Short-term capital is often referred to as Working Capital.

Examples include: Overdraft, short term loan, credit card, and instalments

Question 10

The size of the business:

Answer 10

The bigger the business, the more fixed (long-term) capital it will need to buy machines and vehicles. The bigger the business, the more working capital will be needed for salaries, water and electricity, rent and other expenses.

Question 10

Factors that influence the demand for long-term vs. short-term Capital

The nature of the business:

Answer 10

Manufacturers need more fixed (long-term) capital than
retailers to buy fixed assets such as equipment to establish the manufacturing plant.

Question 11

The stage of development:

Answer 11

If the business is still expanding, it will probably need more
fixed capital to buy additional machines and equipment.

Question 12

Time off production:

Answer 12

The longer it takes to
manufacture the final product

Question 13

Rate of stock turnover:

Answer 13

Stock turnover measures how fast inventory is sold. The
higher the stock turnover, the less additional working capital is required.

Question 14

Buying and selling terms:

Answer 14

If the business buys inventory for cash, but sells on credit it
will need more working capital than a business that sells for cash while buying on credit.

Question 15

Budgeting

What is a budget?

Answer 15

A budget is a tool that will assist the business (or person) to plan how much money will be
available (income) and how it should best (expenditure).

Question 16

The purpose of budgeting:

Answer 16

Budgeting is a tool used for financial planning, because it forces the financial manager to think about the future and what will be needed.

Budgeting helps with the process of financial
decision-making, because the information is available when needed.

Question 17

Types of budgets

A capital budget:

Answer 17

is used to plan fixed capital
requirements. It is a long-term financial planning tool to plan the purchases of fixed assets such as Land & Buildings, Vehicles and Equipment.

Question 18

A cash budget:

Answer 18

is used to do short-term
financial planning. It is used to plan for working capital requirements to cover
payments to creditors, to buy inventory for cash, to finance debtors and to pay for the
expenses associated with the day-to-day running of the business.

Question 19

Selling on credit to a debtor

Credit trading:

Answer 19

When the business sells on credit, the person buying
on credit is called a debtor i.e. a debtor owes money to the business from which it bought goods on credit.

Question 20

Advantages of / reasons for selling on credit:

Answer 20

A business may sell on credit, because by doing so it increases its turnover (sales) and ultimately the profit is increased.

Question 21

Disadvantages of selling on credit:

Answer 21

The business runs the risks of bad debts, i.e.
unpaid accounts that have to be written off.

Question 22

The credit policy of the business

The credit policy will specify the following:

Credit standards:

Answer 22

describe the criteria that
are used when a decision is made whether to grant credit to a customer or not, i.e. the creditworthiness of the potential debtor.

Question 23

The credit period:

Answer 23

refers to how long debtors
have to settle their accounts.

Question 24

The credit limit:

Answer 24

describes the maximum credit
that a specific debtor will be allowed.

Question 25

Cash discount:

Answer 25

is sometimes given to
encourage the debtor to settle the account early.

Question 26

Credit control:

Answer 26

Credit control is very important in any business that sells on credit to debtors because: Increased sales mean higher profits, but also higher risks of bad debt.