Finance Flashcards
List the internal sources of finance
Retained Profits
Sale of Assets
Describe retained profits
This is when profits are kept back from previous years are used to generate more profit in the future. The business reinvests these profits back into the business
What are the advantages of retained profits?
No interest to pay and no need to repay the money invested – so cheaper than alternative sources of finance
Some businesses can raise large sums of money this way
What are the disadvantages of retained profits?
A business may find it difficult to grow if it regularly uses retained profits, especially to solve short term cash flow problems
Describe sale of assets
The selling of assets (items it owns) to raise finance.
What are the advantages of sale of assets?
The money does not need to be repaid
What are the disadvantages of sale of assets?
If finance is needed quickly then the business may have to sell the asset for less than its worth
Describe external sources of finance
These can be:
- Short-Term
- Medium-Term
- Long-Term
External sources of finance include:
- Bank Overdraft (Shirt-Term)
- Debt Factoring (Long-Term)
- Grant
- Bank Loan
- Mortgage
- Share Issue
- Debentures
- Venture Capitalists
- Crowd Funding
Describe a bank overdraft
A facility which allows a business to spend/take out more money than is available in its bank account.
What are the advantages of a bank overdraft?
Usually easy for a business to setup and quick to access finance
The business can continue to pay expenses (e.g. bills) even though there is not money in the account
What are the disadvantages of a bank overdraft?
High interest rates are applied for this type of borrowing- must be repaid quickly or it can be very expensive
Overdraft can be withdrawn by the bank at anytime and must be repaid
Describe debt factoring
This is when a business looks to sell off its debts (rather than wait for its customers to pay them off). They sell the debts to a factor who give them the finance and the factor then chases the customer for payment.
What are the advantages of debt factoring?
Responsibility for collecting the debt is passed on to the factor, saving the business time
Cash flow is improved by receiving an advanced payment of the debts from the factor
What are the disadvantages of debt factoring?
Business sells the customer debt for a reduced amount, i.e. it receive less money than owed
Factoring companies are usually only interested in large amounts of debt
Describe a grant
Money from the government that does not have to be paid back e.g. The Prince’s Trust, central or local government
What are the advantages of a grant?
The money does not need to be repaid and is one lump some of money
What are the disadvantages of a grant?
Complicated to apply for and the business must meet certain requirements
The amount of applicants for the grant will be high – less chance of getting one
Conditioned mat be attached e.g. set up in an area with high unemployment levels
Describe a bank loan
A Bank agrees to lend a business money for a specific purpose, for a fixed period of time. Paid back in monthly instalments with interest is added on.
What are the advantages of a bank loan?
Payments are in regular fixed instalments and this makes it easier to budget for
Large amounts of money can be borrowed
What are the disadvantages of a bank loan?
Interest must be paid along with the amount borrowed
New businesses may find it more difficult to secure a loan and often need to pay higher interest rates
Describe a mortgage
A large sum of money borrowed from a bank to buy a property. Interest is added on to the loan and whole amount is repaid in equal monthly instalments over a long period of time (25 years)
What are the advantages of a mortgage?
It can be paid back over a long period of time
Interest rates are usually lower than a bank loan
Interest rates can be fixed so that the business knows/pays the same every month – good for budgeting
What are the disadvantages of a mortgage?
Interest has to be repaid along with the mortgage amount
Business will need at least a 10% deposit
If business doesn’t pay monthly repayments then property can be repossessed
Describe a share issue
Limited companies can issue extra shares to new or existing shareholders. PLCs can sell shares on the stock market.
What are the advantages of a share issue?
Large amounts of equity can be obtained
Share holders benefit from limited liability
The finance raised does not have to be paid back
What are the disadvantages of a share issue?
The selling price of shares varies daily on the stock market – can rise and fall
Dividends have to be paid to shareholders (share of the profit)
PLC’s can only issue a certain number of shares
Describe debentures
This is a group of loans from individuals and/or other companies. The holders of the debenture receive a fixed amount of interest over the period of the loan and then at the end of the time period (e.g. 25 years) they receive the amount of the loan back.
What are the advantages of debentures?
Large amounts of finance can be raised and can be repaid over a long time
Control of the business is retained
What are the disadvantages of debentures?
Debenture interest must be paid even if the business makes a loss
If the business fails, debenture holders have a right to sell its assets in order to have the loan repaid.
Describe venture capitalists
They provide large loans to businesses that a bank or other lenders may feel are too risky. They usually part own the business in return for taking a risk.
What are the advantages of venture capitalists?
Organisations who have a poor credit rating might be able to get finance from a venture capitalist instead of a bank which sees them as too risky
Large amounts of finance can be obtained
May give advice and support to help improve and/or grow the business
What are the disadvantages of venture capitalists?
Not suitable for small sums of money or for short-term purposes
Part owner ship of the organisation may be a requirement of the loan (loss of control)
Describe crowd funding
The practice of funding a project or venture by raising money from a large number of people who each contribute a relatively small amount, typically via the Internet, e.g. Gofundme, Kickstarter
What are the advantages of crowd funding?
Pitching an idea through the online platform can be a valuable form of marketing and result in media attention
It can be a fast way to raise finance with no upfront fees
What are the disadvantages of crowd funding?
Not all projects that apply to crowdfunding platforms get onto them
If you don’t reach your funding target, any finance that has been pledged will usually be returned to your investors and you will receive nothing
If you haven’t protected your business idea with a patent or copyright, someone may see it on a crowdfunding site and steal your concept
What factors affect the source of finance chosen?
- Short-term finance is needed – e.g. cash flow problems so arrange an overdraft
- Long-term finances is needed–e.g.new property is required so choose a mortgage
- Interest Rates
Lowest interest rates available
Fixed which aid budgeting
Variable which could be unmanageable if the rate rises - Payback Term
The quicker, the less interest the business will pay on borrowing - How much of a deposit is required
- Size of the organisation – smaller businesses will pay higher interest rates
- Type of organisation – Public Sector organisations cannot sell shares and relies on Government funding
Describe cash
Cash is a crucial resource for any organisation.
Businesses will want to make a profit but cash is needed on a day to day basis to operate.
Making a profit and having a healthy cash flow are two different things.
If a business does not have a healthy cash flow they can face problems
Describe cash budgets
A budget is a forecast of the future finances.
To help to predict future cash flow a cash budget can be prepared.
Forecast of the money expected to be received (receipts) and the money expected to be paid out (payments)
Are prepared on a regular basis e.g. monthly.
It is used to highlight possible shortages or surpluses of cash.
List cash receipts (inflows)
Sales Revenue – cash and credit
Loans – Bank or Debetenures
Grants
Investors equity – eg issuing shares
Selling an asset
List cash payments (outflows)
Rent
Wages
Bills
Purchasing inventory
Buying Assets
Shareholders dividends
Why do businesses prepare cash budgets?
It helps to highlight periods when cash flow problems may occur
Allows decisions to be made e.g. whether additional finance is required , for example, a bank overdraft or a loan.
It shows whether the business will have a surplus or a deficit
- Surplus – can be used to buy assets
- Deficit – arrange injection of cash
Helps to control expenses by highlighting periods when expenses could be high
It can be used to make comparisons between actual spending and targeted spending
Can be used to set targets – e.g.sales targets for employees
Describe the impact of poor cash flow
Cannot to pay suppliers
Unable to pay expenses
May need to find a cheaper supplier
May have to offer discounts to encourage Trade Receivables to pay early
May need to sell unused assets
May need to reduce prices of goods
Solvency risk/closure/administration
Give a possible solution for - Not enough money being generated from sales
Increase advertising
Increase Sales by increasing/decreasing selling price
Offer discounts
Give a possible solution for - Increase in inventory/purchase costs
Look for a cheaper supplier – this will reduce the organisations purchases/inventory costs
Negotiate bulk buying discounts or prompt payment discounts
Give a possible solution for - Increase in expenses e.g. bills, wages
Reduce overtime
Let staff go,
Find other suppliers of electricity,
Downsize building to reduce rent
Give a possible solution for - Large sum of cash being spend on non-current assets e.g. equipment
Leasing or hire purchase of equipment – spreads the cost
Bank loan
Selling old equipment that is no longer needed
Give a possible solution for - Negative Closing balances
Arrange a bank overdraft
Take out a bank loan
Describe an income statement
The Income Statement is split into two sections and calculates:
- Trading Section – Gross Profit - the profit made from buying and selling
- Profit and Loss Section – Profit for the Year - the profit made after expenses are deducted
Describe the trading account section of income statements
Records the difference between how much money the business generates from selling (Sales Revenue) and how much the goods, i.e. stock or raw material, it is selling actually cost (Cost of Sales)
It calculates the Gross Profit/Loss. This is the amount of money made from buying and selling. Gross profit is the difference between the sales value and the cost of sales.
It is calculated by Sales Revenue – Cost of Sales.
Describe the profit and loss section of income statements
This follows on from the Gross Profit
This calculates the Profit for the Year/loss that an organisation has made over a financial time period.
It starts with the Gross Profit figure and lists any expenses incurred by the organisation that are not directly linked to trading activities
The profit made after expenses are deducted from the Gross Profit
It is calculated by Gross Profit – expenses = Profit for the Year
Describe expenses
Expenses are costs/overheads incurred by the business.
Therefore money spent by the business that is not related to producing the product.
Examples include:
- Rent & Rates
- Heat & Light
- Insurance
- Advertising
- Office Wages & Salaries
Describe the term trading account
Provides the summary of the business’ trading activity during the financial year
Describe the term profit and loss account
Provides the summary of the business’ expenses during the financial year
Describe the term cost of sales
The cost of the sales to the business i.e. before a sales or profit margin is added
Describe the term gross profit
The profit (or loss) recorded as the difference between the business’ sales and purchases
Describe the term profit of the year
The profit (or loss) recorded after all business expenses have been deducted
What is the purpose of an income statement?
To calculate gross profit
To calculate the cost of sales
To show sales revenue
To calculate the total cost of expenses
To calculate profit for the year
For legal reasons
To aid decision making
What are the reasons for making a loss/less profit?
Sales are decreasing
Less customers purchasing
Selling price of stock is too low
Price of buying stock is too high
Suppliers prices increasing
Purchasing too much inventory - Too much stock left over at the end of the year
Expenses are too high
How do you solve a decrease in gross profit?
Increase Sales Revenue by…
- By increasing the selling price to make more profit on each unit sold
- By decreasing the selling price to increase/encourage sales
- By increasing the volume of sales by advertising – use of Social Media as it is more cost effective
- By increasing the volume of sales through offering trade credit to customers
- By promotion deals –sales, buy one get one free
Decrease Cost of Sales…
- Get a cheaper supplier
- Ask for discounts if buying in bulk/prompt payment
- Introduce JIT and only buy inventory when it is needed
How do you solve a decrease in profit of the year?
Decrease expenses by…
- Reduce wages by letting staff go/stop over time
- Use cheaper alternatives to advertise
- Reduce rent…
- Reduce energy bills
- Find cheaper supplier
- Reduce consumption
How do you calculate sales revenue?
The money a business has made from selling goods and/or services
How do you calculate the cost of sales?
Costs associated directly with the purchase of goods or services.
Calculate by - Opening Stock (stock the business already has) + Purchases (stock the business has bought in that financial year) – Closing Stock (stock that the business has left over)
How do you calculate gross profit?
This is the difference between Sales revenue and Cost of Sales. This money has been made directly from the trading activities of the organisation.
How do you calculate expenses?
All additional expenses incurred by the organisation, for example wages, rent and advertising are listed here.
How do you calculate the profit of the year?
This is the amount of money the organisation has left once all expenses have been deducted from the Gross Profit.
Describe a statement of financial position
Shows the financial worth of the business at a particular point in time.
It shows the value of the organisation’s :
- Assets – what the business owns
- Liabilities – what the business owes to others
- Equity - the money invested into the business
These items are combined in the following accounting equation:
EQUITY = ASSETS - LIABILITIES
Describe assets
Assets are owned by the business. There are 2 types of assets:
- Non-Current Asset
- Current Asset
Describe non-current assets
Items owned by the organisation longer than a year. These will generate income, such as property, equipment, furniture, vehicles, etc. Without these assets the organisation would not be able to operate.
These are items owned by the organisation longer than a year. Without these assets the organisation would not be able to operate.
- computers
- premises
- vans
- office equipment
Describe current assets
Items owned by the organisation that will be used up, sold or converted into cash within twelve months. They include inventory, trade receivables, bank balances and cash.
These are are items owned by the organisation that will be used up, sold or converted into cash within twelve months.
- Inventory
- Trade receivables (money owed by customers)
- Cash and money in the bank.
Describe liabilities
Liabilities are items that are owed by the business.
There are 2 types of liabilities:
- Non-current Liability
- Current Liability
Describe non-current liabilities
These are debts that are owed by the business such as debentures or other long-term loans such as mortgages where the debt repayment is not due within the next twelve months.
There are items owned for longer than 1 year
- Mortgages/long-term loans
Describe current liabilities
These are debts owed that must be repaid in the short term- less than twelve months. They include trade payables (suppliers), bank overdraft.
These are items owed within 1 year e.g.
- trade payables (money owed to suppliers)
- overdraft
Describe equity
The money invested into the business either by the shareholders or owners of the business.
Describe the interpretation of a statement of financial position
May include answering questions such as:
- Do we have sufficient liquid assets to meet our short term debts? (working equity)
- Are we making enough use of free credit available to us?
- Is our level of debt comparable to that of our competitors?
Describe working equity
The business’s ability to pay off their short-term debts. This is money that a business can access immediately, rather than money that is tied up in investments or property.
CA - CL
Describe trade receivables
People (customers) who owe the business money. They have bought goods on trade credit and will pay the business back within a set time e.g. 30 days.
Describe trade payables
People (suppliers) the business owes money to. Business will have got the goods but will pay their supplier at a later date.
Describe dividends
A sum of money paid regularly (typically annually) by a company to its shareholders out of its profits.
List the users of financial information
Banks/Lenders
Employees
Managers
Shareholders
Competitors
Investors
Customers
Trade Payables (Suppliers)
Inland Revenue (HMRC) - Tax
What is the use of ration analysis?
Ratio analysis is used to highlight:
- Profitability
- Efficiency
- Liquidity
Describe profitability
How profitable an organisation is.
Includes:
- Gross Profit Ratio
- Profit of the Year Ratio
- Return on Equity Employed
Describe gross profit ratio
Gross Profit Ratio — (Gross Profit ÷ Sales Revenue) x 100
Used to calculate what the Gross Profit is in relation to the Sales. It shows the profit from buying and selling inventory. The higher the %, the better.
Describe profit of the year ratio
Profit of the Year Ratio — (Profit of the Year ÷ Sales Revenue) x 100
Indicates how well a business controls its expenses. It measures the Profit for the Year in relation to Sales Revenue and is shown as a %. The higher the %, the better
Describe the return on equity employed
Return on Equity Employed — (Profit of the Year ÷ Equity) x 100
Shows the return on the equity investment made by the shareholder. This higher the % the better.
Describe efficiency ratios
How efficiently and effectively the organisation is performing
Rate of Inventory Turnover — (Cost of Sales ÷ Average Inventory)
The answer is expressed as a number of times.
Describe liquidity ratios
The ability of an organisation to pay short- term debts
Includes:
- Current Ratio
- Acid Test Ration
Describe current ratio
Current Ratio — (Current Assets ÷ Current Liabilities)
The answer is expressed as a ?:1.
2:1 is good!!
Describe acid test ratio
Acid Test Ratio — (Current Assets - Closing Inventory) ÷ Current Liabilities
The answer is expressed as a ?:1.
1:1 is acceptable
What does ratio analysis provide:
Compare current performance with previous years
Compare performance with that of similar organisations
Identify differences in performance to decide upon action to take in the future
Highlight trends over a period of time
Identify changes in performance to help decide on future actions.
What are the limitations of ratio analysis?
Information contained in annual accounts is historical as it is based upon last years trading
Comparisons must be made with firms of similar size which are in the same industry.
Findings do not take into account External (PESTEC) factors • Findings do not show the implications of product development or declining products
Findings do not reveal elements such as staff moral or staff turnover
List the uses of technology and financial management
Spreadsheets
Internet
BACS Payment
Sage Software
EFTPOS - Debit/credit card, contactless and Apple Pay
Describe spreadsheets
Most finance departments will use computer software (spreadsheets) to prepare cash budgets and financial accounts
- Formulae calculations are carried out instantly and accurately
- Formulae are amended automatically, when the spreadsheet is amended
- Formulae can be replicated
- Produces graphs and charts easier for people to interpret
- Can use templates for financial statements
- Editing/amending is simplified
- Conditionally format data
- Can secure data with passwords
Describe internet
- Compare suppliers of a bank loan or mortgage
- Compare hire purchase/leasing deals on vehicles
- Tax can be paid online using the Government website
Describe internet banking (online or app)
- Saves time and no longer requires employees to go to the actual bank
- To manage accounts and keep a track of spending
- To transfer money from one account to another
- Make payments to other people or businesses
Describe BACS payment
Bank-to-bank transfers e.g. Direct Debits
- Mortgage payments
- Bills
- Insurance
- Vehicles - leasing
Describe EFTPOS
Electronic Funds Transfer Point of Sale
- Debit Card
- Credit Card
- Contactless payment
- App Payments Apply Pay and Google Pay Less cash within the business
Describe sage software
SAGE is a software package that is used by many businesses to manage and process financial information e.g. invoices
- Computerised – rules out human error
- Less time consuming as it is carried out quicker than if It is done manually
- Cost effective in comparison to paper based accounting
- Monthly subscription fee
Describe powerpoint
- This can be used to present financial information to senior management and shareholders at AGMs.
- Visual displays can help the audience understand the information being presented and keep their attention
