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Business > Finance > Flashcards

Finance Flashcards

1
Q

Overdraft

A

A facility in that the bank lets the business ‘owe it money’ when the bank balance goes below zero. (Short term)

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2
Q

Advantages of overdrafts

A

Relatively easy to arrange
Flexible - only use as cash flow requires
Interest - only paid on the amount borrowed under the facility
Not secured on assets of businesses

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3
Q

Disadvantages of overdrafts

A

Can be withdrawn at short notice
Interest rate varies with changes in interest rate
Higher interest rate than bank loan

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4
Q

Trade credit

A

Making use of an opportunity to defer payment to a supplier. (Short term)

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5
Q

Advantages of trade credit

A

Helps cash flow issues
The business can pay the supplier once they have received the payment for the good being sold

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6
Q

Disadvantage of trade credit

A

If you don’t pay in time, the suppliers may not supply you in credit again

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7
Q

Factoring

A

When a business raises finance by selling their debt to a third party, at a discount, for them to then follow up and collect to receive a profit. (Short term)

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8
Q

Advantages of factoring

A

Amounts owed by customers (receivables) are turned into cash quickly
Businesses can focus on selling rather than collecting debts
There is no security required - unlike a loan or overdraft

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9
Q

Hire purchase

A

Paying for an item in instalments over a period of months or years. The business owns the item after the instalments have been made. (Medium term)

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10
Q

Advantages of hire purchase

A

Quick and easy to raise finance
No security
Will eventually own the item and it will become an asset

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11
Q

Disadvantages of hire purchase

A

Not owned until the item is fully paid for
Interest charged

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12
Q

Bank loan

A

A fixed amount for a fixed term with regular fixed payments. The interest in a loan tends to be lower than an overdraft. (Medium/long term)

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13
Q

Advantages of bank loans

A

Greater certainty of funding, provided terms of loan complied with
Lower interest rate than a bank overdraft
Appropriate method of financing fixed assets
A large sum of money can be borrowed

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14
Q

Disadvantages of bank loans

A

Requires security (collateral)
Interest paid on full amount outstanding
Harder to arrange

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15
Q

Leasing

A

When a business ‘rents’ an item with regular payments but never owns it. (Medium term)

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16
Q

Advantages of leasing

A

Balanced cash flow
Gained access to quality assets
Allows for better budget planning
No risk of obsolescence

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17
Q

Disadvantages of leasing

A

No ownership
Debt
Maintenance of the asset

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18
Q

Retained profit

A

A portion of the business’ profits that is not paid out as dividends to shareholder but is instead retained by the business for future use. (Medium term) - often not considered as a source of finance in exams

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19
Q

Advantages of retained profit

A

Cheap
Very flexible
Do not dilute the ownership of the company

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20
Q

Disadvantages of retained profit

A

Shareholders would prefer to have a higher dividend

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21
Q

Shares

A

Selling a percentage of the business to individuals in return for money. (Long term)

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22
Q

Advantages of shares

A

Don’t take on new debt
No regular payments required, or interest paid
Can choose the price of shares and when they are issued

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23
Q

Disadvantage of shares

A

Loss of ownership
Loss of control

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24
Q

Venture capital / business angels

A

A form of private equity and a type of financing that investors provide to businesses that are believed to have long-term growth potential. (Long term)

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25
Q

Advantages of venture capital

A

Raise a substantial sum of money
Quick and scalable route to expand business
Brings expertise, resources, and technical assistance

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26
Q

Disadvantages of venture capital

A

Investors are likely to demand a significant return
May lose ownership and autonomy

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27
Q

Debenture

A

A loan given to a business by an individual. (Long term)

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28
Q

Advantage of debentures

A

Control of the business is not lost

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29
Q

Disadvantages of debentures

A

Interest must be paid even if the company makes a loss

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30
Q

Critical path analysis

A

A project management technique that requires mapping out every key ask that is necessary to complete a project

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31
Q

Float

A

The amount of time that a task in a project network can be delayed without causing a delay to project completion date

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32
Q

Total float

A

The amount of time that an activity can be delayed from its start date without delaying the finish time of the project

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33
Q

Free float

A

The amount of time an activity can be delayed without causing delay to the next task

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34
Q

Critical path

A

The sequence of project network activities that determine the shortest time possible to complete a project.
Any delays to activities on the critical path will result in delay to the overall completion time of the project.

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35
Q

Advantages of CPA

A

Helps reduce the risk and costs of complex projects
Encourages careful assessment of the requirements of each activity in a project
Helps spot which activities have some slack (‘float’) and could therefore transfer some resources (leading to better allocation of resources)
Provides managers with a useful overview of a complex project
Links well with other aspects of business planning including cash flow forecasting and budgeting

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36
Q

Disadvantages of CPA

A

Reliability of CPA - difficult to make accurate estimates and assumptions
CPA does not guarantee the success of a project - it still needs to be managed properly
Resources may not actually be as flexible as management hope when they come to address the network float
Too many activities could make the network diagram too complicated - activities might have to be broken down into mini-projects

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37
Q

Total float equation

A

LFT (this activity) - duration - EST (this activity)

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38
Q

Free float equation

A

EST (next activity) - duration - EST (this activity)

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39
Q

What are the two parts of capital structure?

A

Debt and equity

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40
Q

Debt

A

Finance provided to the business by external parties

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41
Q

Examples of debt

A

Bank loans
Other long term debt

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42
Q

Equity

A

Amounts of invested by the owners of the business

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43
Q

Examples of equity

A

Share capital
Retained profits

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44
Q

Reasons for higher debt

A

Low interest rates - cheaper to borrow
Don’t want to lose control of the business
Good cash flow - can easily pay it back

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45
Q

Reasons for higher equity

A

Where there is greater business risk (eg start up)
Where more flexibility is required (eg don’t have to pay dividends)

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46
Q

Creditors

A

Who you owe money to

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47
Q

Debtors

A

Who owe you money

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48
Q

What might determine a business’ choice of finance?

A

Whether it is needed for the short term or the long term
The legal structure of the business - some cannot issue shares
The state of the economy - eg interest rates
Having collateral (assets) to support a loan
Quantitative factors (measurable) - have several loans already when applied for
Qualitative factors (not measurable) - eg taking on a partner will increase capital and decrease control but by how much?
External factors (the economy - interest rates, disposable incomes)
Security - lack of security may mean that banks are unwilling to grant a loan
The current method used to finance the business - eg using an overdraft in the wrong way could make a bank loan more difficult to get

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49
Q

Fixed costs

A

Costs that do not change in relation to output
They do changes but not as a consequence of output changing

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50
Q

Examples of fixed costs

A

Rents and rates
Salaries
Advertising
Insurance, banking and legal fees
Software R+D

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51
Q

What are fixed costs also known as?

A

Overheads or indirect costs

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52
Q

Variable costs

A

Costs which change as output varies

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53
Q

Examples of variable costs

A

Raw materials
Piece rates

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54
Q

What are variable costs also known as?

A

Direct costs

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55
Q

Total costs

A

Fixed costs + variable costs

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56
Q

Revenue

A

Cash that flows into a business from the sale of goods and services
It is determined by the number sold and price that they are charged at

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57
Q

Other terms for revenue

A

Income
Sales turnover
Takings

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58
Q

Revenue equation

A

Volume sold x average selling price

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59
Q

Ways to increase revenue

A

Increase volume sold
Increase selling price

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60
Q

Profit equation

A

Total sales - total costs

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61
Q

Costing

A

An act of measuring the effects of any business activity in financial terms

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62
Q

Standard costing

A

The cost the business expects the production of a product or service to be
It is a forecast that gives the business a cost target

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63
Q

Cost centre

A

A specific part of the business where costs can be identified and allocated

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64
Q

How might costs be allocated?

A

The different products that a business produces
The individual department
Location of different business sites
Capital equipment
Physical size

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65
Q

Advantages of cost centres

A

Allows to monitor performance
Motivation of workforce
Look for new supplies or better production techniques

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66
Q

Disadvantages of cost centres

A

Issues collecting data (difficult to separate costs into different departments)
Allocation of costs can impact performance of different branches/departments
Some costs can’t be controlled (eg oil prices)
Some departments may see it as unfair causing internal conflict

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67
Q

Profit centre

A

A separately identifiable part of a business for which it is possible to identify revenue and costs (ie calculate profit)

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68
Q

Examples of profit centres

A

Individual shops in a retail chain
Local branches in a regional or nationwide distribution business
A geographical region (eg a country or region)
A team or individual (eg a sales team, a team of installers)

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69
Q

Advantages of profit centres

A

Provides useful insights into where profit is earned (comparisons can be made)
Supports budgetary control
Can improve motivation (target setting)
Finance can be allocated more effeciently - where it makes the best return

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70
Q

Disadvantages of using profit centres

A

Can be time consuming
May lead to conflict and competition within the business
Potentially de-motivating if profit centre targets are too tough, or if unfair cost allocations are made
Profit centres may pursue their own objectives rather than those of the broader business

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71
Q

Contribution

A

Revenue received from selling a product minus the direct costs of producing that good (variable cost)

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72
Q

Total contribution equation

A

Total revenue - total variable costs

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73
Q

Contribution per unit equation

A

Selling price (per unit) - variable cost (per unit)

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74
Q

Ways to increase contribution per unit

A

Increase the selling price per unit
Lower the variable cost per unit

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75
Q

Break even analysis

A

A method of determining the level of sales at which the company will break even (have no profit or loss)

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76
Q

Margin of safety

A

The difference between the actual (or forecasted) output and the break even output

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77
Q

Strengths of break even

A

Identifies how long it will take before a start-up reaches profitability (sales required)
Helps to understand the viability of a business proposition (helps to obtain finance)
Helps to determine the margin of safety (to determine how far sales can drop before losing money)
Illustrates the importance of controlling costs and setting the correct selling price

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78
Q

Limitations of break even

A

Unrealistic assumptions - price and costs can and do change
Most businesses sell more than one product, so break even for the business becomes harder to calculate
Break even analysis should be seen as a planning aid rather than a decision-making tool

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79
Q

Investment appraisal

A

The process of analysing whether investment projects are worthwhile

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80
Q

3 types of investment appraisal

A

Payback period
Average rate of return
Discounted cash flow (NPV)

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81
Q

Payback period

A

The time it takes for a project to repay its initial investment

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82
Q

Benefits of payback period

A

Simple calculation
Emphasises speed of return
Straight forward to compare projects

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83
Q

Drawbacks of pay back period

A

Ignores cash flows after payback has been reached
Doesn’t take into account how the value of money changes over time
Encourages short term thinking
Simplistic -especially if it’s a complex investment

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84
Q

Average rate of return

A

Looks at the average return for a project to see if it meets the target return

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85
Q

Average rate of return equation

A

(Average annual return ÷ investment) x 100

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86
Q

Average annual return equation

A

Total net profit ÷ number of years

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87
Q

Advantages of ARR

A

Provides a percentage return which can be compared with a target return
Looks at the whole profitability of the project
Focuses on profitability - a key issue for shareholders

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88
Q

Disadvantages of ARR

A

Does not take into account cash flows - only profits (they may not be the same thing)
Takes no account of the value of money
Takes profits arising late in the project in the same way as those which might arise early

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89
Q

Net present value

A

Calculates the monetary value of a project’s future cash flows

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90
Q

Advantages of using NPV

A

Takes account of time value of money, placing emphasis on earlier cash flows
Looks at all the cash flows involved through the life of the project
Use of discounting reduces the impact of long-term, less likely cash flows
Has a decision-making mechanism - rejects projects with negative NPV

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91
Q

Disadvantages of using NPV

A

More complicated method - users may find it hard to understand
Difficult to select the most appropriate discount rate - may lead to good projects being rejected
The NPV calculation is very sensitive to the initial investment cost
Does not consider external factors (based on predictions)

92
Q

Budget

A

A detailed plan for the future concerning the revenues and costs expected over a certain period of time

93
Q

Budgetary control

A

The process by which financial control is exercised within an organisation

94
Q

Managers use budgets to…

A

Control income and expenditure (the traditional use)
Establish priorities and set targets in numerical terms
Provide direction and co-ordination, so that business objectives can be turned into practical reality
Communicate targets from management to employees
Motivate staff
Improve efficiency
Monitor performance

95
Q

Principles for good budgetary control

A

Managerial responsibilities are clearly defined
Performance is monitored against the budget
Corrective action is taken if results differ significantly from the budget
Variances are investigated

96
Q

Variance analysis

A

Involves calculating and investigating the differences between actual results and the budget

97
Q

Favourable (positive) variances

A

Actual figures are better than budgeted figure
Eg- costs lower than expected
Eg - revenue / profits higher than expected

98
Q

Averse (unfavourable) variances

A

Actual figure is worse than the budget figure
Eg- costs higher than expected
Eg- revenue / profits lower than expected

99
Q

Possible causes of favourable variances

A

Stronger demand than expected = higher actual revenue
Selling prices increased higher than budget
Cautious sales and cost assumptions (eg cost contingencies)
Better than expected productivity or efficiency

100
Q

Possible causes of adverse variances

A

Unexpected events lead to unbudgeted costs
Over-spends by budget holders
Sales forecasts prove over-optimistic
Market conditions (eg competitor action) mean demand is lower than budget

101
Q

Zero budgeting

A

An alternative to traditional budgeting
All budgets are set to zero and managers justify any requirements for funds
It helps to prevent a situation where the same money is given each year

102
Q

Flexible budgets

A

These allow a business to make allowances for changes in the level of sales (adverse variances are avoided)

103
Q

Cash flow

A

A dynamic and unpredictable part of life for most businesses (particularly start-ups and small businesses)
Cash flow problems are the main reason why a business fails
Regular and reliable cash flow forecasting can address many of the problems

104
Q

Why produce a cash flow forecast?

A

Advanced warning of cash shortages
Make sure that the business can pay suppliers and employees
Important part of financial control
Provides reassurance to investors and lenders that the business is being managed properly

105
Q

What are the two main kinds of cash flow?

A

Cash inflows and cash outflows

106
Q

Examples of cash inflows

A

Cash sales
Receipts from trade debtors
Sale of fixed assets
Interest on bank balances
Grants
Loans from bank
Share capital invested

107
Q

Examples of cash outflows

A

Payments to suppliers
Wages and salaries
Payments for fixed assets
Tax on profits
Interest on loans and overdrafts
Dividends paid to shareholders
Repayment of loans

108
Q

Main causes of cash flow problems

A

Low profits or (worse) loses
Too much production capacity
Excess inventories held
Allowing customers too much credit and too long to pay
Over trading - growing the business too fast
Seasonal demand

109
Q

How to manage cash flow problems

A

Use reliable cash flow forecasting
Keep costs under control
Manage working capital effectively
Choose the right sources of finance

110
Q

Limitations of cash flow forecasting

A

Changes in interest rates
Changes in economic policy
Forecasts are estimates
Competitor behaviour
Changes in technology

111
Q

Definition of the Principles of Accounting

A

Seven principles that ensure the figures produced are standardised so they can be analysed and viewed by stakeholders with a degree of confidence

112
Q

What are the seven principles of accounting?

A

Consistency
Going concern
Matching
Materiality
Objectivity
Prudence
Realisation

113
Q

Consistency (principles of accounting)

A

Accounts produced in the same way

114
Q

Going concern (principles of accounting)

A

Operating as normal (not in danger of closing)

115
Q

Matching (principles of accounting)

A

Dates used to record financial transactions are when transaction takes place not when the payment is made

116
Q

Materiality (principles of accounting)

A

Value of business needs to be realistic figure, not calculating every asset. (Eg not counting the amount of office stationery)

117
Q

Objectivity (principles of accounting)

A

Accounts must be realistic and based on facts and not opinions and guesses (eg valuing a piece of machinery highly because it is estimated that inflation would increase)

118
Q

Prudence (principles of accounting)

A

Similar to objectivity and is concerned with not overstating the organisations financial situation (principle suggest it is appropriate to take a pessimistic approach regarding possible future profits)

119
Q

Realisation (principles of accounting)

A

Similar to matching, in that realisation takes place when the legal ownership changes hands and not when the payment is made.

120
Q

Generally accepted accountancy practice (GAAP)

A

Framework for accountancy rules (stakeholders can make comparisons knowing businesses all use the same principles)

121
Q

Working capital

A

The capital of a business which is used in its day to day trading operations

122
Q

Working capital equation

A

Current assets - current liabilities

123
Q

Current assets

A

Assets that you can turn into cash within a year

124
Q

Examples of current assets

A

Stock
Cash
Debtors

125
Q

Current liabilities

A

Short term money that you owe

126
Q

Examples of current liabilities

A

Overdraft
Creditors

127
Q

Net current assets equation

A

Current assets (cash + stock + debtors) - current liabilities (creditors + overdraft)
(Same as working capital equation)

128
Q

What are the two main categories of accounting?

A

Financial accounting
Managerial accounting

129
Q

Financial accoutning

A

Concentrates with assets, profits and levels of cash within the business.
This information is issued in the annual report to satisfy external stakeholders

130
Q

Managerial accounting

A

Concentrates on internal records allowing the business to monitor and evaluate performance to set targets

131
Q

Factors affecting the level of working capital

A

Businesses with a lot of cash sales and few credit sales should have minimal trade debtors (eg supermarkets)
Some finished goods, notably food stuffs, have to be sold within a limited period because of their perishable nature
Larger businesses may be able to use their bargaining strength as customers to obtain more favourable, extended credit terms from suppliers
Some business will receive their monies at certain times of the year (seasonal)

132
Q

Depreciation

A

An accounting estimate of the fall in value of a fixed asset over time

133
Q

What are the two main methods of calculating depreciation?

A

Straight line
Reducing balance

134
Q

Straight line equation

A

(Cost - residual value) ÷ estimated useful life

(Residual value = the value of an asset at the end of its useful life)

135
Q

Reducing balance equation

A

Net book value x depreciation rate

(Net book value = the value of the asset)

136
Q

The amount of working capital held by a business depends on a variety of factors:

A

Need to hold inventories
Production lead time
Lean production
Expected credit period by customers
Effectiveness of the credit control function
Credit period offered by suppliers

137
Q

Main causes of working capital problems

A

Poor control of inventories (stocks)
Poor control of receivables (trade debtors)
Ineffective use of payables (trade creditors)
Poor cashlow forecasting
Unexpected events

138
Q

Income statements (profit and loss account)

A

Measures the business performance (income and costs) over a given period of time, usually a year
It shows the profit or loss made by the business - which is the difference between the firm’s total income and its total costs

139
Q

Revenue

A

The amount of money generated by sales

140
Q

Cost of sales

A

The cost of making the goods or buying them (direct cost)
Eg - stock, labour involved in production (piece rates)

141
Q

Gross profit

A

Sales - direct cost of sales

142
Q

Overheads and expenses

A

Costs not directly involved in the production process (indirect costs)
Eg - cost of premises (eg rent, insurance, repairs), office costs (eg stationery, postage, computer maintenance, staff salaries and wages)

143
Q

The usefulness of income statements

A

Progress can be monitored by management and the business can set targets (objectives) and make decisions
Figures can be used to carry out ratio analysis
Provides other stakeholders with valuable information (banks, investors, HMRC, employees, suppliers)

144
Q

Operating profit

A

Gross profit - overheads

145
Q

Balance sheet

A

A snapshot of the business’ assets (what it owns or is owed) and its liabilities (what it owes) on a particular day - usually the last day of a financial period.

146
Q

What might be included under goodwill and intangible assets on a balance sheet?

A

The know-how and experience of staff and management
The value of brands and customer loyalty
Reputation for quality in the market

147
Q

Main elements of current liabilities

A

Trade credit and other payables - trade creditors
Short-term borrowings - overdraft
Current tax liabilities - taxes that still need to be paid to the government
Provisions (eg dividends due to be paid to shareholders, estimates of potential costs which the business might incur in relation to known disputes or other issues)

148
Q

How can financial accounts be used to assess business performance?

A

Comparing performance over time
Comparing performance against competitors or the industry as a whole
Benchmarking against best-in-class businesses

149
Q

Ratio analysis

A

Involves the comparison of financial data to gain insights into business performance

150
Q

Ratio analysis helps to understand…

A

Why one business is more profitable than another
What returns are being earned in investment in a business
If a business is able to stay solvent
How effectively a business is using its assets

151
Q

Gross profit margin

A

(Gross profit ÷ sales revenue) x 100

152
Q

Gross profit

A

Sales revenue - direct costs

153
Q

What might a fall in gross profit margin suggest?

A

Higher costs from suppliers or a decision to sell at lower prices

154
Q

What might an increase in gross profit margin suggest?

A

Better buying from suppliers or selling price rises

155
Q

Net profit margin

A

(Net profit (before tax) ÷ sales revenue) x 100

156
Q

Net profit

A

Sales revenue - costs (direct and indirect)

157
Q

Where can the figures be found for gross and net profit margins?

A

Income statement

158
Q

Return on capital employed (ROCE) is a useful ratio to…

A

Evaluate the overall performance of the business
Provide a target return for individual projects
Benchmark performance with competitors

159
Q

ROCE equation

A

(Operating profit (or net profit) ÷ total equity + non current liabilities) x 100

160
Q

Capital employed equation

A

Total equity + non current liabilities

161
Q

Return on equity

A

Measures the ability of a business to generate profits from its shareholders investments into the business

162
Q

Return on equity equation

A

(Operating profit ÷ total equity) x 100

163
Q

Liquidity

A

Measures the ability to convert assets into cash
(Cash being the most liquid asset)

164
Q

Current ratio

A

Estimates whether the business can pay debts due within 1 years out of the current assets

165
Q

Current ratio equation

A

(Current assets ÷ current liabilities)

166
Q

Evaluating current ratio

A

Ratio of 1.5-2.0 suggests efficient management of working capital
Low ratio (<1) indicates cash flow problems
High ratio may indicate too much working capital

167
Q

Acid test ratio

A

Ability to pay off short term debts without your stock (you may not sell it)
It is a more reliable test of liquidity

168
Q

Acid test ratio equation

A

((Current assets - stock) ÷ current liabilities)

169
Q

Interpreting liquidity results

A

A better indicator of liquidity problems for businesses that usually hold inventories
Significantly less than 1 is often bad news

170
Q

Economies of scale

A

When unit costs fall as output rises

171
Q

Disconomies of scale

A

When unit costs rise as output rises

172
Q

Why do businesses grow?

A

Greater profits
Increased market share
More chance of survival
Cost reduction

173
Q

Internal economies of scale

A

Arise from the increased output of the business itself

174
Q

Purchasing EOS

A

Achieved via buying in bulk

175
Q

Financial EOS

A

As a firm gets larger it is able to access business loans more easily at lower rates of interest

176
Q

Managerial EOS

A

As a firm expands, it is able to afford more specialist managers in different areas of the business

177
Q

Technical EOS

A

As a firm expands, it is able to afford better technology and capital equipment to help with the running of its operations

178
Q

Marketing EOS

A

As a firm increases its product range it is able to market all its products under its brand/logo

179
Q

Risk bearing EOS

A

As a firm becomes larger, it is able to grow their product range - allowing them to diversify their risk as they are not relying on only one product or service

180
Q

External economies of scale

A

Occur within an industry
(ie all competitors benefit)

181
Q

Concentration EOS

A

When firms within the same industry cluster together, they can take advantage of the existing infrastructure and supply networks.
Skilled workers tend to shift close to such clusters, giving firms easy availability to labour

182
Q

Examples of diseconomies of scale

A

Poor communication
Lack of motivation
Loss of direction and co-ordination

183
Q

Benefits of economies of scale

A

Lower production costs
Increase profitability
Offer lower prices
Provide a competitive advantage

184
Q

Drawbacks of economies of scale

A

Decrease flexibility
Increase bureaucracy
Risk of diseconomies of scale

185
Q

Trade receivables (debtors)

A

Amounts owed to a business by customers

186
Q

Trade payables (creditors)

A

Amounts owed by a business to suppliers and others

187
Q

Receivables days

A

The average length of time taken by customers to pay amounts owed

188
Q

Payables days

A

The average length of time taken by a business to pay amounts it owes

189
Q

Receivables days equation

A

(Trade receivables ÷ revenue) x 365

190
Q

Payables days equation

A

(Trade payables ÷ cost of sales) x 365

191
Q

Asset turnover

A

This ratio measures how efficiently a business is able to use its net assets to generate sales revenue

192
Q

Asset turnover equation

A

Sales revenue ÷ net assets (assets-liabilities)

193
Q

Evaluating asset turnover

A

In general a higher number is better
Low numbers compared to previous years or competitors may suggest a problem with generating sales revenue with the assets you have

194
Q

Stock turnover

A

This ratio measures how quickly the stock is turned over (sold)

195
Q

Stock turnover equation (number of times)

A

Cost of sales ÷ stock

196
Q

Interpreting stock turnover

A

In general, a higher number is better
Low number (compared with previous period or competitors) suggests problem with stock control

197
Q

Issues to consider with stock turnover

A

Stock turnover varies from industry to industry
Holding more stock may improve customer service and allow the business to meet demand
Seasonal fluctuations in demand during the year may not be reflected in the calculations
Stock turnover is irrelevant for many service sector businesses (but not retailers, distributors etc)

198
Q

Gearing ratio

A

All about how a business is financed and the relationship between the amount of finance provided by equity and debt

199
Q

Gearing equation

A

(Non current liabilities ÷ total equity + non current liabilities ) x100

200
Q

Benefits of high gearing

A

Less capital required to be invested by the shareholders
Debt can be a relatively cheap source of finance compared with dividends
Easy to pay interest if cash flows and profits are strong

201
Q

Benefits of low gearing

A

Less risk of defaulting on debts
Shareholders rather than debt providers ‘call the shots’
Business has the capacity to add debt if required

202
Q

What percentage reflects a highly geared business

A

Above 50% (more debt than equity)

203
Q

What percentage reflects a lowly geared business

A

Below 50% (more equity than debt)

204
Q

Ways to reduce gearing

A

Focus on profit improvement (eg cost minimisation)
Repay long term loans
Retain profits rather than pay dividends
Issue more shares
Convert loans into equity

205
Q

Ways to increase gearing

A

Focus on growth - invest in revenue growth rather than profit
Convert short term debt into long term loans
Buy back ordinary shares
Pay increased dividends out of retained earnings
Issue preference shares or debentures

206
Q

Interest cover

A

This ratio measures the number of times in which a business can pay its interest charges with the operating profit it makes
The higher the number the better (indicates that the business can easily afford the interest payments)

207
Q

Interest cover equation

A

Operating profit ÷ interest payable

208
Q

What do shareholder ratios do?

A

Measure the return that shareholders gain from their investment
Rewards for shareholder = capital gain (share price increasing), shareholder dividends (percentage of profit)

209
Q

Dividend per share equation

A

Total dividends paid ÷ number of shares in issue

210
Q

Interpreting dividend per share

A

A basic calculation of the return per share
Problems = we don’t know how much the shareholder paid for the shares, we don’t know how much profit per share was earned which might have been distributed as a dividend

211
Q

Dividend yield equation

A

(Dividend per share ÷ share price) x 100

212
Q

Evaluating dividend yield

A

Yield can be compared with industry standard, rates of return on alternative investment
Shareholders consider dividend yield in deciding whether to invest in the first place
Unusually high yield might suggest an under-valued share price or a possible dividend fault
Dividend yield will change constantly as the share price changes

213
Q

Total net assets equation

A

Total assets - total liabilities

214
Q

Solvency

A

The ability of a company to pay its debts and other financial obligations

215
Q

What does it mean when a business is solvent?

A

When its assets are more than liabilities (able to pay its debts) —> link to current and acid test ratios.

216
Q

What does it mean when a company is insolvent?

A

When it can’t pay its debts

217
Q

Dividend cover

A

A measure of how many times dividends can be paid from the net profits

218
Q

Dividend cover equation

A

Profit after tax ÷ dividends

219
Q

Interpreting dividend cover

A

If the DCR > 1 it indicates that the profit is enough to pay shareholders with their dividends
A DCR > 2 is considered good
A consistently low or a deteriorating dividend cover may signal poor company profitability in the future, which may mean the company will be unable to sustain its current levels of dividend pay-outs

220
Q

Earnings per share

A

Shows how much profit each share generates

221
Q

Earnings per share equation

A

Profit after tax ÷ number of shares issued

222
Q

Price earning ratio

A

This ratio is a measure of confidence about what the shares will earn
The ratio compares the current market price with the earning for that share

223
Q

Price earning ratio equation

A

Share price ÷ earnings per share

224
Q

Stepped fixed costs

A

A cost that changes when maximum capacity has been breached.
When the threshold of maximum capacity has been breached the fixed cost must change to accommodate this.
(Eg if a machine can only produce up to 10,000 units, but the business scales up production to 12,000 units it is necessary to purchase an additional machine. This increased production level increases the cost of machinery, making it a step cost)

225
Q

Stock turnover equation (number of days)

A

(Stock (inventories) ÷ cost of sales) x 365

Business (21 decks)

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