Finance Flashcards
1
Q
What is capital expenditure?
A
Finance spent on fixed assets with long-term function, e.g., land,
buildings, equipment, machinery, vehicles.
2
Q
What is revenue expenditure?
A
Payments for the daily running of the business, e.g., wages, rent,
raw materials, electr
3
Q
What are internal sources of finance?
A
Personal funds, retained profits, and sale of assets.
4
Q
What are external sources of finance?
A
Share capital, loan capital (mortgages, business development
loans, debentures), overdrafts, trade credit, grants, subsidies,
debt factoring, and leasing.
5
Q
What is cost?
A
Expenditure in producing an item.
6
Q
What is price?
A
Amount paid by the customer to buy an item.
7
Q
What are the types of costs?
A
Fixed costs, variable costs, semi-variable costs, direct costs, and
indirect costs (overheads).
8
Q
What are fixed costs?
A
Costs that have to be paid even if there is no output fixed. Costs of production that a business has to pay regardless of output, e.g., rent, interest payments, advertising, salaries, stationery, security
9
Q
What are variable costs?
A
Costs of production that change in proportion with the level of
output or sales.
10
Q
What are semi-variable costs?
A
Costs that contain an element of both fixed and variable costs,
changing only when production or sales exceed a certain level of
output.
11
Q
What are direct costs?
A
Cost specifically related to an individual project or the output of a
particular product without which the costs would not be incurred.
12
Q
What are indirect costs?
A
Costs that cannot be clearly traced to the production or sale of
any single product; also known as overheads.
13
Q
What is revenue?
A
Money coming into a business, usually from its sales, calculated
as Price x Quantity Sold.
14
Q
What are examples of non-sales revenue streams?
A
Advertising Revenue, Transactions fees, Franchise costs and
royalties, Sponsorship revenue, Subscription Fee, Merchandise,
Dividends, Donations, Interest earnings, Subvention.
15
Q
Why is ratio analysis used by shareholders, banks, and managers?
A
To assess and compare company performance using profitability
ratios, liquidity ratios, and financial efficiency ratios.
16
Q
What is the formula for Gross Profit Margin?
A
Gross profit margin = (Gross profit / Total sales revenue) x 100
17
Q
What is the formula for Net Profit Margin?
A
Net profit margin = (Net profit before interest and tax / Total sales
revenue) x 100
18
Q
What is the purpose of profit margin ratios?
A
Profit margin ratios assess how successful a business’s management has been at converting sales revenue into gross and net profit.
19
Q
What do profit margin ratios measure?
A
Profit margin ratios are used to measure the performance of a
company and its management team.
20
Q
What are personal funds?
A
A source of finance for free traders that mostly comes from their
personal savings mostly for sole traders. By investing personal
savings, sole traders maximize their control over a business.
21
Q
What are some disadvantages of using personal funds for
business financing?
A
It poses a larger risk on the sole trader, because they could be
investing their life savings, hence putting a strain on their family
or personal life. If savings are not sufficient it may be difficult to
start or maintain the business especially if personal funds are the
only source of funding. They may have to pay the funds back or
rely on outside investors or lenders who could decide to withdraw
their support at any moment.
22
Q
What are some advantages of using retained profit for business financing?
A
It is cheap, since it does not incur interest charges like banks do.
It is a permanent source of finance, as it does not have to be repaid. It is flexible as it can be used in a way as the business deems it fit. The owners have control over their retained profit, without the interference of financial institutions such as banks.
23
Q
What are some disadvantages of using retained profit for
business financing?
A
Start-up businesses will not have any retained profit as they are
new ventures. If retained profit is low, it may not be sufficient for
the business to grow or expand. A high retained profit may mean
that the business did not pay any dividends to their share
holders, which may be less attractive to stock buyers than a
profitable business which pays their share holders dividends.
24
Q
What are some advantages of sales of assets as a source of
finance?
A
No interest or borrowing costs incurred. This is a good way for raising cash from capital that is tied up in the assets which are not being used.
25
Explain sales of assets
When a business sells its unwanted or unused assets to raise funds. Assets that are no longer required by the business include obsolete machinery or redundant buildings. To raise cash the business may sell any excess land or equipment they may not be using.
26
What are some disadvantages of selling assets as a source of
finance?
It may be more suitable for established businesses, since new
businesses may lack assets to sell. It can be time consuming to
find a buyer for the assets especially if the asset is obsolete
machinery.
27
What is a sale and lease back approach?
A business can adopt a sale and lease back approach, which
involves selling an asset that the business still needs to use.
28
What are the Short-term sources of finance?
Bank Overdraft, Hire Purchase, Trade Credit, Leasing, Debt
Factoring
29
What are the Long-term sources of finance?
Share Capital, Ordinary Shares, Preference Shares, Deferred
Shares, Loan Capital Mortgage, Debentures, Industrial
Specialists, Government, Other Financial Institutions
30
What is Profit?
Retained profit is profit after tax that has not been returned to the
owner. This is the most crucial source of finance for any business
- around 65 of all funding comes from retained profits
31
What is Working capital?
A measurement of short-term financial health of a firm. It is
defined as current assets such as products in stock, customers
delayed payments for goods a firm sold which we call credit
minus current liabilities such as firms delayed payments for
supplies they bought from suppliers.
32
What is Sale of assets?
Some established businesses might be able to sell some
unwanted assets to raise finance like machinery, land or buildings
it no longer requires. A good option in that case could be sale
and leaseback.
33
What is Share capital?
or a limited company, share capital is likely to be the most
important source of finance, since this source of finance raises
very large amounts of financial capital. Once shares have been
sold by a company, the buyers of those shares are entitled to a
share in the profits of the company i.e. dividends. The shares of
PLCs are sold in a special share market called the stock market.
34
What are the three types of shares that a business could issue?
Ordinary shares, Preference shares, and Deferred shares.
35
What is a debenture holder?
The holder of a debenture is a creditor of the company, not an
owner. This means that holders are entitled to an agreed fixed
rate of return, but have no voting rights and the amount borrowed
must be repaid by the expiry date.
36
Can smaller firms raise funds from the sale of shares and
debentures?
No, only limited companies can raise funds from the sale of
shares and debentures. Smaller firms need long-term finances to
purchase the premises, a purpose which mortgages are
designed for.
37
What is a mortgage?
It is usually a long-term loan from a financial institution like a
bank and the lender must use land or property as security on the
loan. Mortgages are specialised long-term loans only for the
purchase of premises, not machinery
38
What do industrial loan specialists do?
These are specialised organisations that provide funds for
businesses. Some of them are venture capitalists that often invest
their own funds in businesses that have a potential, but are still
considered too risky by banks for example. In return, they ask for
an equity stake.
39
What are some examples of government assistance for
businesses?
There might be business start-up schemes developed by local or
central governments of countries in order to provide small start-
up businesses with a small amount of income for a limited period
of time. These might include lower taxes for start-ups.
40
What is bank overdraft?
Bank overdraft is probably the most important source of finance
for most businesses. The amount by which a business goes
overdrawn depends on its needs and the time.
41
Advantage of Hire purchase
Quick and easy to acquire equipment
42
Disadvantage of Hire purchase
The good can be taken away from the buyer if their payment is
late. Interest rates are higher
43
Advantage of Trade credit
An interest free source of finance
44
Disadvantage of Trade credit
The cost of goods can be higher if paid for at a later date. Delaying the payment can result in a poor relationship between the firm and its suppliers
45
Advantages of Leasing
No large sums of money need to be allocated for the purchase of
the equipment
Maintenance is not the responsibility of the user
Useful when equipment is used occasionally
46
Disadvantages of Leasing
In the long term, it is more expensive than the outright purchase
Interest rates are higher
Not able to secure any loans with another institution on assets
that are leased
47
What is autonomous investment?
Investment that replaces worn-out capital goods.
48
What is induced investment?
New investments that businesses undertake to increase market
share or satisfy increased demand.
49
What does investment appraisal describe?
How a business might objectively evaluate an investment project
to determine its profitability and compare different investment
projects.
50
What are the main quantitative methods a business might use
when evaluating projects?
Based on Capital cost the amount of money spent on the new
investment, Net cash flow the amount of money the business
expects to receive each year over the life of the investment
project minus the estimated running cost and Payback period
51
What does the payback period indicate?
The amount of time it takes for a project to recover or pay back
the initial outlay.
52
How do you calculate the payback period?
Payback in last negative year / Net cash flow in first positive year
* 12
53
What does ARR measure?
ARR measures the net return each year as a percentage of the
capital cost of the investment.
54
What do all these numbers mean in the context of ARR?
Net cash flow column will be given to you in the case study. It is
the cash flow businesses expected over the years. You start with
0 and since the number is negative it represents expenditure in
our case 50000. In the net profit section, all we did was add up all
the expected cash influx in each year and then subtract the value
of the investment. Then we calculated the net profit per annum -
what the profit of the firm will be in those five years after
subtracting the value of the investment in our case 20000 / 5
years = 4000. Then we calculate the ARR using the formula Dont
worry about memorizing this formula it will be in your formula
booklet in the exam. ARR = Net return (profit per annum) / Cost
of the investment * 100. We got that the ARR is 8. If we used this
method to appraise different investment projects, we would
choose the investment that has the highest average rate of return
55
56
What do all these numbers mean in the context of NPV?
The case study will tell you what discount rate to use all the
discount values will be provided in your formula booklet. So, what
you need to do is multiply every years net cash flow with the
number from the discount table. After doing that, we sum up all
the values and we get the present value of the predicted net cash
flow for every year. Finally, to find the NVP, subtract the value of
the investment from the present value cash flow. If we used this
method to appraise different investment projects, we would
choose the investment with the highest NPV.
57
List the advantages and disadvantages of Payback period, ARR
and NPV.
Payback period: Simple, cheap, not time consuming. Indicates
when the investment will be paid off. Ignores the profitability of a
project. Does not take into account figures for net cash flow.
ARR: Clearly shows the profitability of the project. More realistic.
All the figures for net cash flow are predicted. Ignores the time
dimension. Does not take the effect of time on the value of money
into account.
NPV: Very realistic. All the figures for net
58
How do you calculate working capital?
Working capital = current assets - current liabilities
59
What are some examples of cash injections?
Loans, fresh capital, sale of assets, non-operating income
60
What are some examples of cash drains?
Dividends, drawings, repay loans, new assets, tax
61
What happens in Lag 1 of the working capital cycle?
Businesses purchase raw materials from suppliers on credit.
62
What happens in Lag 2 of the working capital cycle?
Businesses use resources to produce different goods.
63
What happens in Lag 3 of the working capital cycle?
Finished goods are stored by a business before they are sold to
customers.
64
What happens in Lag 4 of the working capital cycle?
Customers could ask for credit, delaying their payment.
65
What is poor control of debtors?
Failing to collect debts on time or giving credit to firms that fail.
66
What does overstocking mean?
Keeping too much stock, indicating inefficient management.
67
What is insufficient working capital?
Insufficient working capital for its level of turnover. For example, a
business might accept orders from customers, but be limited by
trade credit limits set by its suppliers. Therefore it cannot order
enough stock to complete the orders. Overdraft might be a
solution, but bankers might refuse because of the risk of failure of
the business.
68
What is overborrowing?
Businesses can borrow too much in the short term and trade too
much credit from suppliers. If the business fails to pay on time, it
can lose the business discounts for paying on time or even
refusal by suppliers to supply in the future. Overdraft might be a
solution but bankers might refuse for the same reason as above.
69
What are downturns in demand?
When the economy goes into recession, orders and sales of
businesses fall, because businesses do not react quickly enough.
This can cause overstocking which can also lead to cash flow
problems.
70
What is cash flow?
Cash flow is a continuous movement of cash in and out of the
business.
71
What is cash flow forecast?
Cash flow forecast is the prediction of all expected receipts
inflows and expenses outflows of a business over a future time
period, which shows the expected cash balance at the end of
each month.
72
What can investing too much in fixed assets lead to?
It can lead to insufficient cash funds, which paralyses the
business as it is no longer able to produce. Therefore, it is better
to lease some of the necessary fixed assets and have enough
liquid assets to support production and sales.
73
What happens during overtrading?
It occurs when business does not have enough cash and other
liquid resources to finance its production and sales
74
What can investing too much in fixed assets lead to?
It can lead to insufficient cash funds, which paralyses the
business as it is no longer able to produce. Therefore, it is better
to lease some of the necessary fixed assets and have it enough
liquid assets to support production and sales.
75
Why is stock control an important feature of managing liquid
assets?
Cash tied up in stocks is unproductive.
76
What does 'allowing too much credit' mean for a business?
This means that the business is waiting for liquid assets to be
able to support future production. Therefore, better control of
debtors is necessary for healthy cash flow.
77
What might taking too much credit result in?
It might result in difficulties in obtaining future supplies from
suppliers.
78
Why is stock control an important feature of managing liquid
assets?
Cash tied up in stocks is unproductive.
79
What does 'allowing too much credit' mean for a business?
This means that the business is waiting for liquid assets to be
able to support future production. Therefore, better control of
debtors is necessary for healthy cash flow.
80
What might taking too much credit result in?
It might result in difficulties in obtaining future supplies from
suppliers.
81
How can cash flow be improved?
This can be done in a few ways such as using overdraft facilities,
selling off reducing stocks, using a factoring company, selling off
non-vital fixed assets, introducing some fresh capital etc.
82
What is a budget?
Budget an economic plan a business makes in order to target
revenue or costs it must aim to reach over a given period of time
83
Why is it important to plan expected future revenues and costs?
The bigger the business, the more difficult it is to control its
finances.
84
How do setting objectives and targets help control a business?
It helps coordinating many activities in the company, forces
businesses to think ahead and also motivates employees.
85
What is a variance?
A variance is the difference between the figure that the business
has budgeted for and the actual figure. Variances can be
favourable or adverse .
86
When do favourable variances occur?
Favourable variances occur when the actual figures are better
than the budgeted ones. For example, if costs were planned to be
20000, but turned out to be 18000, there is a favourable variance
of 2000, as actual costs were lower than planned.
87
What is the final step in variance analysis?
The final step in variance analysis is thinking about how these
results can be used in decision-making. It is important to identify
the reasons why variances have occurred, so that they can be
taken into account in future strategic planning
88
What is a profit and loss account (aka income statement)?
A profit and loss account is a financial document showing a
company's revenue (income) and costs (expenditure) over a
particular period of time, usually a year.
89
What is Sales revenue?
This is the income from selling goods and services.
90
What is cost of goods sold?
This figure includes direct costs such as raw materials and
wages of labour used to produce those products. It also includes
the indirect costs such as rent the company pays for the factory.
91
What is gross profit?
This is the profit a company made by selling goods services it
produces, and we calculate it by subtracting cost of goods sold
from sales revenue.
92
What are expenses?
These are overheads that are not involved in the production of
goods and services, but still represent costs the firm needs to
account for.
93
How do we get NPBIT (Net Profit before Interest and Tax)?
We get this number by subtracting expenses from the gross
profit. NPBIT is the profit made by a company as a result of its
ordinary trading activities and is often regarded as key indicator
of trading performance.
94
What are interest and tax?
Interest refers to interest the business is paying for loans it took
from financial institutions. Tax is obviously what business needs
to pay to the government.
95
How to calculate net profit after interest and tax?
We calculate this number by subtracting interest and tax from
NPBIT.
96
What are dividends?
This is the share in profit shareholders of the company get based
on the size of their share in the company.
97
What is retained profit?
This is the final figure of the profit and loss account. If its positive
the firm made a profit and if its negative the firm made a loss.
98
What is a balance sheet?
A balance sheet is like a photograph of the financial position of a
business at a particular point of time. It contains information
about the Assets the resources a business owns and uses. They
are usually divided into fixed and current assets. Fixed assets
have a lifespan of more than one year and are used by the
business in the production process. Current assets are assets
that are likely to be changed into cash within a year. Liabilities the
debts of a business basically what the business owes to other
businesses suppliers, individuals or institutions. Liabilities are a
source of funds for the business. They can be short term or long
term . Capital the financial means introduced by the owners of
the business. It is another source of funds and can be used to
purchase assets.
99
What are fixed assets?
Assets which are not expected to be sold within 12 months.
100
What are tangible assets?
Tangible assets include property, plants, and equipment.
101
What are intangible assets?
Intangible assets include goodwill, copyrights, and trademarks.
102
What are current assets?
Current assets are assets likely to be converted into cash within
one year, such as stocks, debtors, and cash.
103
What are current liabilities?
Current liabilities are debts of the business that need to be paid
within one year, including creditors, short-term borrowing, tax,
and dividends.
104
What is net current assets?
Net current assets, also known as working capital, are calculated
by subtracting current liabilities from current assets.
105
How to calculate total assets less current liabilities?
Total assets less current liabilities are calculated by subtracting
current liabilities from the sum of current assets and fixed assets.
106
What are long-term liabilities?
Long-term liabilities include mortgages to acquire new buildings
or long-term loans.
107
How to calculate net assets?
Net assets are calculated as total assets less current liabilities
and long-term liabilities.
108
What is share capital?
Share capital is the financial means introduced by the owners of
the business when they buy shares, which becomes a source of
funding for the business to buy assets.
109
What are retained profits?
Retained profits are the amount of profit that the business has
made in previous years.
110
When is everything balanced in a balance sheet?
Everything is balanced when all assets equal all liabilities, so
when net assets equal capital.
111
What is capital employed?
Long-term liabilities, share capital, and retained profits are
sometimes referred to as capital employed.
112
What does depreciation indicate?
Depreciation indicates how much of a fixed asset's value has
been used up.
113
Describe the straight line method of calculating depreciation.
The straight line method assumes that a fixed asset depreciates
by the same value every year. The depreciation allowance is
calculated as (Original cost - residual value) / Expected life in
years.
114
Describe the reducing balance method of calculating
depreciation.
The reducing balance method assumes that the depreciation
charge in the early years of an asset's life should be higher than
in later years. The asset is written off by the same percentage
rate each year.
115
116
117
What is ratio analysis?
Ratio analysis is a form of interpretation of the financial data that
was previously presented in the form of final accounts. Financial
data is used by a range of stakeholders to assess the business.
118
What do profitability ratios help show?
Profitability ratios show how well a business is doing, focusing on
profit, capital employed, and total revenue. Examples include
gross profit margin and net profit margin.
119
How is gross profit margin calculated, and is a higher or lower
margin preferred?
Gross profit margin = (gross profit / sales revenue) * 100. Higher
margins are preferable.
120
How is net profit margin calculated, and is a higher or lower
margin preferred?
Net profit margin = (net profit before interest and tax / sales revenue) * 100. Higher margin is better.
121
What do liquidity ratios illustrate, and what is their focus?
Liquidity ratios illustrate the solvency of a business by focusing
on short-term assets and liabilities to determine if it can repay its
day-to-day debts. Examples include the current ratio and acid test ratio
122
How is the current ratio calculated, and what does a ratio of 1
indicate?
Current ratio = Current assets / current liabilities. A ratio of 1
means the business has exactly enough current assets to cover
current liabilities. Managers should aim for a current ratio of 1.5.
123
124
How is the acid test ratio calculated, and what does a ratio of less
than 1 indicate?
Acid test ratio = (Current assets - stock) / Current liabilities. If the
ratio is less than 1, current assets less stock cannot cover current
liabilities.
125
What is a desirable outcome for stock turnover?
It is generally considered desirable to sell stock as quickly as
possible.
126
How is stock turnover assessed?
We assess it by calculating how many days it takes the business
to sell the stock using the formula: (Average stock / Cost of goods
sold) * 365. The number we get will be in days.
127
What does higher stock turnover mean?
Higher stock turnover means that profit on the sale of stock is
earned more quickly, which allows these businesses to operate
on lower profit margins.
128
What might lower stock turnover indicate?
Lower stock turnover might be due to piling up of stock, slow
moving stock, a lack of control over purchasing etc.
129
What does a high ROCE indicate?
If the return is high, this means that the business is profitable,
which would yield high dividends that current shareholders and
potential investors are on the lookout for.
130
How is ROCE calculated?
ROCE = (NPBIT / Capital employed) * 100. The higher the
ROCE, the bigger the return.
130
What does ROCE compare?
Return on capital employed (ROCE) compares the profit made by
the business with the amount of money invested.
131
What does creditor days measure?
This ratio measures how quickly a business pays its debts to its
suppliers and other short term creditors.
132
How are creditor days calculated?
Creditor days = (Creditors / Total credit purchases) * 365
133
What does higher creditor days mean?
Higher creditor days means that it takes the business longer to
pay for its debts, which can be a benefit, but the business needs
to be careful not to damage its relations with the supplier he
might not allow credits in the future.
134
How should creditor days compare to debtor days?
In general, creditor days should be higher than debtor days this
will improve cash flow
135
What do debtor days measure?
Debtor days measures the efficiency of a business credit control
system. It gives the average number of days it takes to collect
debts from customers.
136
How are debtor days calculated?
Debtor days = (Debtors / Sales revenue) * 365
137
What is a desirable outcome for the debtor days ratio?
The debtor days ratio should be as low as possible, as this would
mean that it takes the business a very short period of time to
collect its debts.
138
What does the gearing ratio show?
The gearing ratio shows the relationship between the loan capital
and share capital of the business. In other words, how much the
company relies on internal and external sources of business
when it comes to choosing the source of finance to invest in the
business.
139
How is the gearing ratio calculated?
Gearing ratio = (Loan capital / Total capital employed) * 100
139
What are Ordinary shares?
The most common type of share issued. The size of the dividend
depends on how much profit is made and how much the directors
decide to retain in the business. When a share is first sold, it has
a nominal value shown- its original value. However, share prices
change as they are bought and sold again and again.
139
140
What does it mean if the gearing ratio is high?
If this ratio is high, we say that the company is high geared, which means that the business relies much more on loan capital than share capital when it comes to investing.
141
What does it mean if the gearing ratio is low?
When the number is low, we say that the company is low geared
and it relies on share capital much more.
142
What are the advantages of low gearing (relying more on share
capital)?
Advantages: The burden of loan repayments is reduced the
business does not need to pay interest, because it is using share
capital more. Volatile interest rates are not a problem anymore if
the interest rates increase, there is no issue as the business does
not rely on loans that much. Ownership not diluted.
143
144
Why has the company's debt been significantly reduced?
The company's debt is much reduced because dividends are
signed off whenever there is profit.
145
What are the disadvantages of dividend payments?
Dividend payments have to be met indefinitely. Ownership of the
company can be diluted, and selling shares puts the company at
risk of being bought by an external party.
146
What risks are associated with interest payments?
Interest payments need to be met. Changing volatile interest
rates can cause the repayments to increase, worsening the
financial situation of the company, causing insolvency.
147
What are Deferred shares?
These are not often used. The founders of the company usually
hold these. These shareholders only receive a dividend after the
ordinary shareholders have been paid a minimum amount.
148
What is Government assistance?
There might be business start-up schemes developed by local or
central governments of countries in order to provide small start-
up businesses with a small amount of income for a limited period
of time. These might include lower taxes for start-ups. Note This
type of funding cannot be a major source of finance for a firm.
149
What are Preference shares?
The owner of these shares receives a fixed rate of return when a
dividend is declared, and usually they are held by the share
owners of the business. They can be redeemable if there is a
possibility of the business buying them back from their owner.
