Chapter 14

Question 1

Who uses Financial ratios?

Answer 1

Financial ratios are used by:
financial management, suppliers of borrowed capital, labour unions and investment analyst.

Question 2

What do the uses of financial ratios use them for?

Answer 2

Financial management uses financial ratios with the view to internal control planning and decision-making. Supplies have borrowed capital use financial ratios to evaluate the ability of the business to pay debt and interest investment analyst use the financial ratios to evaluate the business as an investment opportunity lastly, labour unions use the financial ratios with a view to salary negotiations.

Question 3

What do liquidity ratios indicate and what are some of the liquidity ratios?

Answer 3

Liquidity ratios measure risk and provide indication of ability of a business to meet its short term obligations.
The current ratio and acid test ratio.

Question 4

What is the solvency ratio used for? And which ratios does it include?

Answer 4

Solvency ratio is used to evaluate the ability of a business to repay its debts from sale of assets on cessation (end) of its activities.
Debt ratio (total debt : total assets)
Gearing ratio (owner’s equity : total debt)

Question 5

Define profitability and name the four profitability ratios.

Answer 5

Profitability can be defined as the ability of a business to generate income that will exceeded cost.
The four profitability ratios are gross profit margin, net profit margin, return on investment and return on owner’s equity. These ratios are also called rate of return or yield ratio.

Question 6

Define the means of financial planning and control.

Answer 6

Financial planning and control is done by the means of a budget. A budget can be defined as a formal written plan of future action to implement the strategy of the business and to achieve the goals with limited resources.

Question 7

What is the focal points of budget in a control system?

Answer 7

Responsibility is assigned to income cost profit and investment centres.
Income centre, outputs measured in monetary terms. Cost centre, inputs measured in monetary terms. Profit centre, performance measured by monetary difference between income and cost Investment centre, monetary value of input and output again measured, but profit also assessed in terms of assets employed.

Question 8

What is the difference between manufacturing-cost budget and
Discretionary cost budgets?

Answer 8

Manufacturing cost budgets are used where output can be measured accurately while discretionary cost budgets are not used to assess efficiency because performance standards for discretionary expenses are difficult to devise.

Question 9

What are Financial budgets?

Answer 9

Financial budgets are used by financial management for execution of financial planning and control. They consist of capital expenditure, cash, financing and balance sheet budget.

Question 10

What is the difference between traditional budgeting and zero base budgeting?

Answer 10

Traditional budgeting uses actual income expenditure of previous year as basis for adjustments. While, zero-base budgeting enables businesses to look at its activities and priorities afresh on an annual basis because historic results are not taken as basis for the next budgeting period.

Question 11

What are the two factors that play a role in asset management?

Answer 11

The two factors that play a role in the management of current assets are cost and risk.
Over investment in current asset results in a low degree of risk while under investment increases risk of cash/inventory shortages.

Question 12

What are the two factors that play a role in asset management?

Answer 12

The two factors that play a role in the management of current assets are cost and risk.
Over investment in current asset results in a low degree of risk while under investment increases risk of cash inventory shortages.

Question 13

What is the cost of holding too much and too little cash?

Answer 13

Cost of holding cash are the following:
Loss of interest,
Loss of purchasing power.
Cost of little or no cash are the following:
Loss of goodwill,
Loss of opportunities,
Inability to claim discounts,
Cost of borrowing.

Question 14

What are the three reasons for a business to have a certain amount of cash available?

Answer 14

Transaction motive, precautionary motive and speculative motive.

Question 15

Define cash budget and name it components.

Answer 15

Cash budget is a detailed plan of future cash flows for a specific period. The cash budget is composed of three elements, namely, cash receipts, cash payments and net changes in cash.

Question 16

What does cash management focus on?

Answer 16

The cash cycle and the cash budget.

Question 17

Discuss the cash cycle.

Answer 17

The cash cycle indicates the time it takes to complete the following cycle:
1. Investing cash in raw materials
2. Converting the raw materials to finish product.
3. Selling finish products on credit.
4. Ending cycle by collecting cash.

Cash -> raw materials -> finish products -> debtors-> cash.

Question 18

What is financial function concerned with?

Answer 18

Financial function is concerned with the flow of funds:
• the acquisition of funds (financing).
• the acquisition of assets (investing).
• the administration of reporting on financial matters (accounting).

Question 19

What is the financial management concerned with?

Answer 19

The financial management is concerned with:
• financial analysis, reporting, planning and control
• management of application of funds (asset structure)
• management of acquisition of funds (capital structure).

Question 20

What are the tools used for financial management for analysis?

Answer 20

The statement of financial performance, the statement of financial position and financial ratios.

Question 21

Define capital.

Answer 21

Capital is the accrued power of disposal of products used to generate profit.

Question 22

Define income.

Answer 22

Income can be defined as the receipts resulting from the sale of products or services.

Question 23

Define cost.

Answer 23

Can be defined as monetary value sacrificed in production of products or services.

Question 24

What are the long-term and short-term financial objectives of financial management?

Answer 24

The long-term objective of financial management is to increase the value of business. This can be done by investing more in assets and by keeping the cost of capital as low as possible.

Short-term financial objective is to ensure profitability liquidity and solvency of the business. Profitability is the ability of a business to generate income that will exceeded cost. Liquidities ability of a business to satisfy short-term credits by due dates solving the extent to which assets exceeded liabilities.

Question 25

What are the three principles that financial management is based on?

Answer 25

The three principles of financial management is based on are:
1. The risk return principle – greater the risk, greater the rate of return.
2. The cost benefit principle – ensuring benefits always exceeded cost
3. The time value of money principle – value of any amount of money can be increased by earning interest.

Question 26

Define the breakeven point.

Answer 26

Breakeven point can be defined as the number of units where no profit or loss is made.

Question 27

What is the difference between trade credit and consumer credit?

Answer 27

Consumer credit is credit granted to individuals while credit is granted to businesses.

Question 28

Discuss credit policy.

Answer 28

The credit policy contains information and decisions of who to grand credit and how much. The 4 Cs of credit that determine whether a consumer will be granted credit are character (customer’s willingness to pay), capacity (customer’s ability to pay), capital (consumer’s financial resources), conditions (current economic/ business conditions).

Question 29

What is the collection policy and what are the cost of granting credit?

Answer 29

The collection policy are the guidelines for collection of debtor accounts that are overdue. The cost of credit includes:
• Loss of interest,
• Cost associated with determining customers creditworthiness,
• Administration and record-keeping cost and
• Bad debts.

Question 30

What is the cost of holding too much inventory and too little inventory?

Answer 30

The cost of holding too much stock include:
•Lost interest,
•Storage cost,
•Obsolescence,
•Insurance cost.
The cost of holding two little stock include:
•The loss of consumer goodwill,
•Production interruption dislocation,
•Loss of flexibility,
•Re-order costs.

Question 31

Clearly distinguish between financial markets, financial institutions and financial intermediation.

Answer 31

Financial markets are channels through which the holders of excess funds make funds available to those who require additional financing.

Financial institutions act as intermediaries between the savers and those with shortage of funds in the financial market.

Financial intermediation is a process whereby financial institutions full fund from savers and make these funds available to those requiring financing.

Question 32

What are primary markets?

Answer 32

A primary market is a market where new issues of financial claims, also known as securities, are made.

Question 33

What is a secondary market?

Answer 33

Trading in securities after they have been issued occurs in the secondary market.

Question 34

Define the money market.

Answer 34

Money market is a market for financial instruments with short-term maturity.

Question 35

Define the capital market.

Answer 35

The capital market is a market where funds required for long-term investments are raised and traded by investors.

Question 36

What are the two broad types of financial institutions?

Answer 36

Financial institutions can be divided into two broad types:
Deposit taking institutions (bank) and non-deposit taking institutions (short term insurers).

Question 37

What are the most common sources of short-term financing for a business?

Answer 37

Trade credit, accruals, factoring and bank overdrafts.

Question 38

Define trade credit.

Answer 38

Trade occurs mainly in the form of suppliers credit. Some advantages are: it is informal, it is more flexible than other sources of short term financing and readily available to businesses that pay their supplier’s on time.

Question 39

Define factoring.

Answer 39

Factoring involves the sale of receive a bus to a data financing company. It is where the financial undertakes to administer and control collection of debt.

Question 40

What are the two types that shareholders equity or interest is divided into?
What are the two types of ordinary shares that can be issued by a company?

Answer 40

Share shoulders interest can be divided into owner’s equity and preference-shareholders’ capital.

Two types of ordinary shares are:
• Par value - these shares have the same value
• Non-par value - the value of these shares differs.
A business can only issue one of the two types of shares.

Question 41

What are the two sources of long-term financing?

Answer 41

Loans and financial leasing.

Question 42

What are the three types of long-term loans?

Answer 42

• Debentures – Can be traded on financial markets.
• Bonds – these loans that are issued with fixed asset as security.
• Registered term loans – unsecured loans.

Question 43

Define financial leasing and also state the two forms of financial leasing.

Answer 43

Financial leasing is a contract that provides light of use of an asset, that is legally owned by the lessor, in exchange for a specified rent paid by the lessee.
Two types of financial leasing are:
Direct financial leasing – the lease amount is payable in regular instalments.
Leaseback agreement – this is where certain assets are sold on credit to credit suppliers and at the same time leased back by business according to a long-term agreement.

Question 44

Sources of financing for small businesses include:

Answer 44

Personal funds
Selling capital shares
Admitting partners
Mortgage loans
Loans from commercial banks
Loan from friends or relatives

Question 45

Sources of financing for small businesses include:

Answer 45

Personal funds
Selling capital shares
Admitting partners
Mortgage loans
Loans from commercial banks
Loan from friends or relatives