Finance

Question 1

Identify the different sources of finance available to a business

Answer 1

owner investment
retained profit
external finance
bank overdraft
mortgage
bank loan
hire purchase
leasing
loans from family and friends
grant
share issue
crowd funding
venture capital

Question 2

Identify the main factors that influence the types of finance used by a business

Answer 2

The main factors are:

the purpose of the finance, eg bank overdraft or mortgage
the objectives of the organisation, eg profit maximisation or business expansion
the cost and amount of finance required – the difference in interest rates and payment terms
the type of business – eg, small businesses may need overdraft to ensure cash flow
the length of time the finance is required - eg, a mortgage is a long term loan for a building

Question 3

Compare advantages and disadvantages of Owner Investment with Retained Profit as a source of finance

Answer 3

Owner Investment
Advantages: Does not need to be repaid. Full control of the business is maintained.
Disadvantages: Personal savings may be lost if the business is unsuccessful.
Retained Profit
Advantages: Does not need to be repaid. Full control of the business is maintained.
Disadvantages: For profits to build up to use in this way can take too long and good business opportunities missed.

Question 4

Explain Bank Overdraft and describe advantages and disadvantages of this type of finance

Answer 4

A bank overdraft allows a business to withdraw more money from its bank account than it has available. It’s a short term source of finance.

Advantages: Flexible and can be arranged quickly.
Disadvantages: An overdraft is costlier, since a higher rate of interest is charged. Usually only available for small sums of money.

Question 5

Explain Bank Loan and describe advantages and disadvantages of this type of finance

Answer 5

A bank loan is a long term source of finance. It is a fixed amount of money that is given to a business by the bank that has to be repaid over time with interest, usually in monthly instalments.

Advantages: Can be arranged quickly. Loan can be repaid over a long period.
Disadvantages: Interest has to be paid in addition to the loan amount. The amounts of finance that can be borrowed are relatively small

Question 6

Explain Mortgage and describe advantages and disadvantages of this type of finance

Answer 6

A mortgage is a long term source of finance. It is a sum of money borrowed from the bank that is secured against a property and paid back in instalments, usually over a long period of time. It is most commonly used for the purchase of property or buildings.

Advantages: Mortgage is given for a long period of time. Large amounts of finance can be raised quickly.
Disadvantages: Interest is charged on the loan. Property can be lost to the lender if repayments are missed.

Question 7

Explain Hire Purchase and describe advantages and disadvantages of this type of finance

Answer 7

Hire purchase is used to purchase an asset, such as a lorry or factory machines. A deposit is paid and the remaining amount for the asset is paid in monthly instalments over a set period of time. The business does not own the item until all payments are made.

Advantages: Expensive assets can be purchased and paid back over time, so does not drain the business of money.
Disadvantages: Interest charges can be expensive. Equipment is not owned until the final payment is made.

Question 8

Explain Leasing and describe advantages and disadvantages of this type of finance

Answer 8

Leasing is a way of renting an asset that the business requires, such as a company car. Monthly payments are made, and the leasing company is responsible for the provision and upkeep of the leased item.

Advantages: Assets can be acquired without having to pay a large amount of money up front. The leasing company is usually responsible for repairs and maintenance.
Disadvantages: Over time it can be a more expensive way to acquire assets and they are never owned by the business.

Question 9

Describe advantages and disadvantages of Loans from Family or Friends as a source of finance

Answer 9

Advantages: Cheap if there is no interest to be paid. Money may not need to be paid back.
Disadvantages: Money may be lost if the business is not successful. Disagreements and arguments may occur between family members.

Question 10

Explain a Grant and describe advantages and disadvantages of this type of finance

Answer 10

A grant is a fixed amount of money usually awarded by the government, EU (European Union) or charitable organisations. Grants are given to a business on the condition that they meet certain criteria such as providing jobs in areas of high unemployment.

Advantages: Very cheap since a grant does not need to be paid back.
Disadvantages: Business needs to meet certain criteria. It is time-consuming to apply for grants and to complete the paperwork.

Question 11

Explain Share Issue and describe advantages and disadvantages of this type of finance

Answer 11

Share issue is a source of finance that is available only to limited companies. When a business needs more funds, it can issue more shares in the company and obtain finance from their sale to the public or existing shareholders.

Advantages: Finance raised does not need to be paid back. Large amounts of finance can be raised.
Disadvantages: Shareholders become part owners of the business and require to be paid a dividend each year.

Question 12

Explain Crowd Funding and describe advantages and disadvantages of this type of finance

Answer 12

Crowd funding involves getting small amounts of finance from a large amount of people. This is usually done through social media or crowd funding websites. Crowd funding investors may donate money, get rewards for their investment, and receive a share of the profits.

Advantages: Crowd funding is a quick way to raise finance and it gives access to large amounts of investors. The owners of the business do not have to risk their own cash at the start.
Disadvantages: Crowd funding investors may require rewards for their investment, such as a share of the profits. Also, a public request for investment risks the project being copied by competitors.

Question 13

Explain Venture Capital and describe advantages and disadvantages of this type of finance

Answer 13

Venture capital is money that investors provide to a company that is starting up or expanding. Venture capital is usually used when there is an element of risk with the business.

Advantages: Available where the investment carried a higher level of risk, which puts off usual lenders.
Disadvantages: Lenders may demand a higher return due to the higher risk of the investment. Lenders may want a share of the business meaning some control may be lost.

Question 14

Explain the importance of Cash Flow is to a business and give reasons why cash flow problems may occur

Answer 14

Cash is generated by a business through the sale of goods or provision of a service. It is important that businesses have enough cash to pay employees, buy supplies and cover business expenses. Cash flow is all the money that comes into and goes out of a business. There must be more cash coming into the business than there is going out to avoid the company going into liquidation. This would mean they are no longer able to trade.

Cash flow problems may occur for many reasons: low sales, too much money tied up in stock, customers taking too long to pay their bills, owner taking too much money out of the business, over-investments in new assets such as machinery, and increase in expenses.

Question 15

Explain the term ‘Liquidation’

Answer 15

When a business ceases trading due to not being able to pay its debts. The business assets are sold to pay for the outstanding debts of the business.

Question 16

Describe different ways of solving cash flow problems

Answer 16

Ways of solving cash flow problems include: finding a cheaper supplier, leasing machinery or equipment instead of buying, selling assets, applying for a bank loan or overdraft, offering discounts to customers for quick payment, arranging extra time to pay bills to suppliers, increasing advertising or sales promotion to generate more demand.

Question 17

Explain the term Cash Budget and describe the benefits of cash budgeting to a business

Answer 17

A cash budget is a plan of expected cash receipts and payments during a future period of time. These cash inflows and outflows include sales revenue, expenses paid, and loans receipts and payments. So, a cash budget is an estimated projection of the organisation’s cash position in the future.

Benefits: Budgeting can identify any times where there may be a shortage of cash. This will allow the business to plan ahead and arrange extra funding such as a bank overdraft. Any months where expenses are high will be highlighted so that business knows to make sure that there is enough cash to cover these. It will clearly show where a business has more cash than expected (surplus) or less cash than expected (deficit). This will allow a business to plan more effectively and make better decisions.

Question 18

Explain the terms ‘Opening Balance’ and Closing Balance on a cash budget

Answer 18

Opening balance is the amount of money have available at the beginning of the month. It is the same amount as the closing balance from the month before.

Closing balance is the cash left at the end of the month after all payments have been taken away from the business receipts.

Question 19

Explain the terms ‘Receipts’ and ‘Payments’ on a cash budget, giving examples of each

Answer 19

Receipts is a list of all the money coming into the business such as sales or rent received.

Payments is a list of all money expected to flow out of a business such as rent, wages or fuel.

Question 20

Explain the meaning of Income Statement and why businesses produce such documents

Answer 20

An income statement (profit statement) statement shows the profit or loss made by a company over a set period of time. Income statements show both the gross profit and the net profit made by a company.

Reasons to prepare an income statement include:

to calculate total costs
to calculate cost of sales
to calculate the profit/loss made for the year
legal reasons (companies are required by law to produce an income statement)
for tax reasons (businesses must pay tax on profits to the Government)
compare with previous year’s results
compare with competitors

Question 21

Explain the terms ‘Gross Profit’ and ‘Net Profit’ on an income statement and how they are calculated

Answer 21

Sales
The total value of the goods sold to customers.

Cost of sales
The direct cost of the goods that have been sold for example the raw materials used to make the product. It is calculated by adding the opening stock to purchases then subtracting the closing stock.

Expenses
All the indirect costs incurred by the business such as rent, wages and electricity.

Question 22

Explain the terms ‘Gross Profit’ and ‘Net Profit’ on an income statement and how they are calculated

Answer 22

Gross profit
The difference between the sales and the cost of sales.

Net profit
The actual profit made by the business after all expenses have been deducted.

Example
Sales £300,000; Cost of Sales £150,000; Expenses £50,000

So, Sales £300,000 less Cost of Sales £150,000 = Gross Profit £150,000

Then, Gross Profit £150,000 less Expenses £50,000 = Net Profit £100,000

Question 23

I can describe the role of technology in managing finance

Answer 23

Spreadsheets
Spreadsheets can be used in the finance department to produce graphs and charts of financial information. The formulae function within the spreadsheet can be used to carry out instant calculations accurately. Formulae will also amend calculations automatically when the spreadsheet is updated. Cash budgeting is one of the main functions where a spreadsheet supports financial planning. ‘What if’ scenarios can be carried out using spreadsheets set up with IF statements and appropriate formulae.

Financial Software
Financial software (such as SAGE) is commonly used to manage and process financial information, eg: generating invoices, managing payroll and completing tax returns

BACS
BACS is an electronic system used to make payments directly from one bank account to another. It enables a business to transfer money securely and quickly between bank accounts and is commonly used to pay staff wages or to pay suppliers.

EFTPOS
Electronic funds transfer point of sale (EFTPOS) is an electronic method of paying for goods This can be done through debit card, credit card, contactless and app payments such as Apple Pay and Google Pay

Online Banking
Online banking (via the Internet) means there is less cash within the business, leading to greater security. This saves the business time as it reduces the need for employees to take trips to the bank. Fund transfers can be made instantly and more conveniently as they are completed through phone apps or by using computers. Finance departments can also use online banking to import banking information into their accounting software. Increased computer security is required to safely process information and banking can only be processed if the technology is working.