FINANCE Flashcards
What is short term finance ?
Money that is needed to run the day to day operations of a business
What is an overdraft ?
When you can withdraw money that you do not currently have - interest at high levels are placed on overdraft
What is a bank loan ?
An amount of money borrowed from a bank . Usually for a fixed period of time / they may want security of an asset if it is not paid
What is trade credit ?
When businesses Buy now and pay later to suppliers or contractors / they will be paid over a period of time or at once
What is factoring ?
The sale of assets to a specialist firm who secures payment and charges commission for the service
What is hire purchase ?
Obtaining items in return for a payment over a period of time / they do not become your property until the final payment is made
What is leasing ?
Obtaining an item for a period of time . At the end , the product goes back to the owner . Usually very expensive products or tech
What is long term sources of finance ? q
Finance used to secure resources for the long term future of the company . E.g borrowing or issuing shares
What is a long term loan ?
A loan which uses property or some other asset to act as security for the loan
What are debentures ?
A long term loan secured against an asset - for a fixed period of time . E.G premium seats at Wimbledon or a box at a football stadium
What is share issue ?
The creation of new shares for a company / A quick way to raise finance
What are shares/ordinary shares ?
What are preference shares ?
Shares paid before ordinary shareholders , a fixed rate of return which dividends can be carried over to next year
What are rights issue ?
Existing shareholders given the right to buy new shares at a discounted rate
What is bonus / scrip issue ?
Company gives out more shares rather than paying them out to shareholders
What is retained profit ?
Profit made from the business is kept back for their own use / cheapest method
What is a mortgage ?
. A large loan . A long term method of finance which requires a form of asset backed as security . Interest can be fixed or variable
What do businesses consider when creating a price for their products ?
Their objectives
Competitors pricing
What are factors that affect price ?
Nature of the product
Cost of production
Demand
Competition
Consumer incomes
What is investment appraisal ?
The means of assessing where an investment is worthwhile or not
What are the 3 types of investment appraisal ?
Payback period
Accounting rate of return
Net present value
Why do companies invest ?
To buy equipment /machinery . To increase efficiency so they can produce more
What is Pay back method ?
Measures how quickly an investment is paid back
Can be used to see the viability of an investment compared to other ones
Give an example on how to calculate the pay back method ?
Machine costs £600,000
Sell items at £5 per unit
Produces 60,000 units per year
60,000 X 5 = £300,000 per year
£600,000 / £300,000 = 2 years
What are the advantages of the payback method ?
Easy to do and cost effective
Quick in assessing the risk involved
Effective in markets that are always changing
What are the disadvantages of the pay back method ?
Ignores the value of money over time ( inflation )
Does not consider inflows after Payback period
Does not show what time of year the inflows will occur
Does not measure levels of profit from the investment
What is accounting rate of return ?
A comparison of the profit generated by the investment with the cost of the investment
What are some advantages of using accounting rate of return ?
Takes into account all cashflows throughout the lifetime of the investment
measures its profitability
allows simple comparision between 2 or more investments
What are some disadvantages of using accounting rate of return ?
Ignores the value of money over time
Life of investment needs to be known
Harder to calculate from payback method
Doesn’t show what time the inflows come in during the year
Give a step by step guide on how to calculate ARR (accounting rate of return )
1 . Total all inflows
2. Profit = total Inflows - cost of investment
3. Average annual profit = profit / life of the asset
4. ( average annual profit / cost of investment ) x 100
What is net present value ?
Takes into consideration the interest and the time of an investment
What is the formula for net present value ?
Amount of money / ( 1+interest rate / 100 )^number of years
What are the advantages of net present value ?
Takes into account the value of money over time
All cashflows are accounted for
What are some disadvantages of net present value
More difficult to work out than AAR and payback methods
More complex=longer decision making = more expensive
decision making tool limited by selection of discount factors
What are fixed costs ?
costs which do not change regardless of output
E.g: Rent , Insurance , Salary
What are variable costs ?
Costs which change with output
E.g Wages , electricity , parking
What are stepped fixed cost ?
For a short time , fixed costs may rise E.g rent may increase
How do we calculate total costs ?
Fixed cost + variable costs
How do we calculate unit cost ?
Total cost / units produced
What are marginal costs ?
The cost of producing one more unit
What is social cost ?
The cost society bears . E.g pollution and noise pollution
What is opportunity cost ?
Cost of choosing one decision over another
How do we calculate contribution
Selling price - variable cost
( they go towards paying fixed costs )
What is a budget ?
A plan for the future which considers the resources available / allows them to monitor monetary values of revenue
What are some reasons why a business will budget ?
Measures the effectiveness of activities
Ensuring adequate cashflow
Gives managers information to manage a department
What is Zero Budgeting ?
All budgets in all departments are set to 0
Managers have to justify why they need the funds
Prevents the same money being allocated in the same areas / very time consuming
What are flexible budgets ?
Allowances for changes to sales levels
E.g if sales increase , then raw materials will need to increase
What is variance ?
The difference between the budgeted figure and the actual figure
What is variance analysis ?
A positive variance improves profit - negative V reduces profit
V allows managers to see what areas are doing well or not
Name some reasons for favorable variances for sales
Better advertising
Budget may be set too low
Competitors leaving the market
Lower prices increase sales
Name some reasons for favorable variances for production
Costs have decreased
Economies of scale achieved
Discounts offered to them
Incorrect budget set
Name some reasons for adverse variance for sales
Poor advertising
Higher costs means higher price
Better competition
Budgets set too high
Name some reasons for adverse variance for production
High costs
Change of suppliers
Material shortages
Incorrect set budget
What are cashflow statements / forecasts ?
Estimates inflows and outflows for a business / usually done over a period of time
What are some reasons for doing a cashflow forecast ?
Valuable planning procedure
Helps set prices for products
Allows strategies to be placed
used to manage the business
What are some limitations of cashflow forecast ?
Does not consider :
Changes to Interest rates
Changes in economic policy
Changes in technology
Changes in competitors behavior
What are some causes of cashflow problems ?
Fall in sales
Changes in the business environment
Excess stock / paid before manufacture
Late payment from debtors
Overtrading stresses cashflow
How do businesses improve cashflow ?
Increase sales
reduce the price of products
Factoring ( selling off debts )
Cut operating costs
What are profit margins ?
The relationship between profit and sales - indicate how effectively costs are being managed
What is the formula for gross profit margin ? `
Gross profit
—————— X100
Sales turnover
What is the formula for gross profit ?
Revenue - Cost of producing
the product
What could be the reason for a low gross profit margin ?
Increased cost of raw materials
Reduced selling price
Stock being lost / poor managment
What is the formula for net profit margin ?
Net profit
—————— X100
Sales turnover
What is the formula for net profit ?
Gross profit - any other expenses
What is liquidity ?
The amount of cash available in the business to meet daily requirements / meet debts
What is the formula for current ratio ?
Current assets
——————— = X:1
Current liabilities
What does an ideal 1:1 ratio look like ?
1:1 - for every £1 in short term asset there is £1 in short term debt
Below 1:1 is dangerously low cash to meet debts
What is the acids test ratio ?
current assets ( less stock ) / current liabilities
What is return on capital ? ( ROCE )
Expresses profit of a business as a % of capital invested
Relates profit to the size of the business
Higher % = Higher performance
What is the formula for ROCE ?
Net profit
————— X100
Capital
employed
