Finance: 3.1 - 3.4 Flashcards
What is expenditure?
Spending money on inputs
What is capital expenditure?
goods used to produce other goods, and aren’t used up in the production process
What are some examples of capital expenditure?
Machinery, buildings, factories, equipment
What are the time terms of capital/revenue expenditure?
capital - long term
revenue - short term
What are fixed assets?
assets kept for 1+ year, also considered capital expenditure
What is the importance of capital expenditure?
increases scope of operations and adds economic benefit
What is revenue expenditure?
goods consumed/used up in the production process, where they become part of the final product. it is done consistently
What are some examples of revenue expenditure?
labour, raw materials, rent, legal expenses, marketing
What are internal sources of finance?
from internal stakeholders
- personal funds (sole traders)
- retained profit
- sale of business assets
What are the three main types of external sources of finance?
- equity finance
- debt finance
- other sources
What is trade credit?
willingness to offer product on credit, agreeing to receive payment at a later date - short term
What are advantages of trade credit?
- trust relationship created
- can form regular customers
- helps purchaser’s cash flow
- no interest
- no loss of control
- will have more cash for production for a period of time
What are disadvantages of trade credit?
- can damage relations
- can ruin reputations
What is share capital?
capital raised by selling shares in the stock market
What are advantages of share capital?
- no need to be repaid
- permanent and long term
- no interest or debts
- publicly held companies can sell additional shares
What are disadvantages of share capital?
- shareholders must be paid dividends
- loss of control and ownership
- IPOs are expensive
- only for publicly held companies
What are business angels?
capital raised by funding from a wealthy person who wants to invest and get richer
What are advantages of business angels?
- helps those not on stock market
- good for start ups and new businesses who struggle with the bank
- expertise and mentorship
- helps inexperienced entrepreneurs
- long term
What are disadvantages of business angels?
- risky for angels, no guarantees
- rare to find
- loss of control and ownership
- potential conflict
What is loan capital?
capital raised from getting loans
What are advantages of loan capital?
- regular, smaller, more accessible payments
- larger businesses may negotiate lower interests
- no loss of control/ownership
- long term
What are disadvantages of loan capital?
- interests
- must be paid back
- collateral may be offered and taken
- interest increases
- inaccessible for sole traders and very small businesses
What is overdraft?
banks allowing businesses to withdraw more money than they have from their accounts - like a very short term loan
What are advantages of overdrafts?
- easily obtainable
- emergency funds when necessary
- may help with cash flow problems
- flexibility
What are disadvantages of overdrafts?
- usually very high interests
- usually only small amount
- repayments may be ordered at short notice
- high cost and short term
- may start a cycle of cash flow problems
What is microfinancing?
basically a social bank - providing those in poor/vulnerable positions with loans and money that would be otherwise difficult to obtain
What are advantages of microfinancing?
- reduces poverty
- encourages (especially female) financial independence
- helps wider community
- social purpose
What are disadvantages of microfinancing?
- unethical to gain profits from poor people
- small scale
- high interest may be charged
- may increase debts
- low profitability - difficulty attracting employees
What is crowdfunding?
raising funds by obtaining small amounts of money from many different stakeholders, usually in exchange for the product (stakeholders only charged after threshold reached)
What are advantages of crowdfunding?
- limits risk and impacts if business fails
- no need for banks
- less costly than stock exchange
- no loss of control
- no debt/interest
- can help small/medium businesses
- long term
What are disadvantages of crowdfunding?
- legal challenges
- investors may ask for more information, causing delays
- theft of intellectual property risk
- possible scams
- must be able to attract enough to pass threshold
What is leasing?
the process of a lessee renting an asset over a certain period of time
What are advantages of leasing?
- reduces capital expenditure
- lessor has responsibility for asset
- good if only needed for shorter period of time
- no need to maintain/repair
- can be used for assets that depreciate quickly
What are disadvantages of leasing?
- lessee never owns the asset
- for too long, can be more expensive than buying
What are fixed costs?
costs that do not change as output changes
What are examples of fixed costs?
- rent (short term)
- salaries
- advertising
- legal/administrative costs
What are variable costs?
costs that change as output changes
What are examples of variable costs?
- wages
- raw materials
Total costs formula
TC = FC + (AVC x Q)
What are direct costs + examples?
costs that go into the production of a good or service like wages and raw materials
What are indirect costs?
costs that cannot be individualised to each good produced ad aren’t directly associated to production
What are examples of indirect costs?
- cleaning supplies
- cleaners/support staff
- rent/lighting/heating
- loan installments
- advertising
- accountancy
- board of directors
- HR dpt
- infrastructure
How are indirect (overheads) costs seen?
- less desirable
- ‘lost’ money
- eats up profit and doesn’t contribute to the product/service
What is contribution?
whatever is left over after paying variable costs, which may be directed towards fixed costs/perhaps profit
Profit formula
Profit = (P x Q) - FC - (AVC x Q)
Contribution formula
TR - (AVC x Q)
total revenue - total variable costs
What are patents?
legal protection given to an inventor of a product to safeguard it from being copied for a certain period of time (average 20 years)
What is a copyright?
legal protection given to creative producers (eg music, books, movies, photos, images…), protecting their exclusive right to publish/sell the artistic works
What is a registered trademark?
A distinctive mark, sign, or symbol that a company uses for identification
What is goodwill?
the intangible value of a company derived from its ‘good nature’ of business
seen when selling price is higher than value of net assets of a company
What is revenue?
the income that a business earns from selling goods and services
What are revenue streams?
one specific way that a company generates income
What are effects of having multiple and diverse revenue streams?
it becomes more resilient, if revenue from one area declines due to external factors, the business is still earning revenue
Why would managers want the final accounts?
- how easily a business can cover its immediate, short and medium term debts, ensuring that the company doesn’t become insolvent
- annual profit
- value of assets owned
- amount of money invested by shareholders
What is management?
refers to people in the organisation that plan, organise, coordinate and control the business’ activities
What might owners and shareholders use the final accounts for?
identifying how effectively their money has been invested and how much in dividends they will receive
Why might employees be interested in seeing the final accounts?
- to know the financial stability of the business and the security of their jobs
- to be able to negotiate for better wages based on business profits
Why would a government be interested in the final accounts?
may wish to assess taxes on business based on profits
assess health of business and if it is able to keep contributing to society, or if it needs supoort
Why would a competitor be interested in seeing the final accounts?
to assess the overall financial strength of the company and compare profits for the year of businesses in the same industry
Why would banks be interested in seeing final accounts?
to see if the business has the ability to repay loans
Why would suppliers be interested in the final accounts?
to assess how effectively the company would be able to pay for goods supplied to it on credit
Why would the local community be interested in seeing the final accounts?
assessing if the business is financially stable, able to keep providing jobs, goods, and services necessary
The statement of profit or loss is also known as
the income statement
The income statement is also known as
the statement of profit or loss
What is the statement of profit or loss
a statement that records sale revenues and costs of a business. shows profit or loss generated from a business’ trading activities.
determines the net profit and distribution of profit.
gross profit (income statement)
sales revenue - COGS
profit before interest and tax (income statement)
gross profit - expenses (overheads)
net profit is also known as
profit before interest and tax
profit before tax (income statement)
profit before interest and tax - interest
profit for the period (income statement)
profit before tax - tax
retained profit (income statement)
profit for the period - dividends
What are the differences in the profit and loss statements for profit and non for profit enterprises?
- profits are recorded as surpluses
- they pay no taxes
- pay no dividends as there are no shareholders
balance sheet is also known as
the statement of financial position
the statement of financial position is also known as
the balance sheet
What is the balance sheet?
set of final accounts that shows the value of a business’ assets, liabilities and equity at a specific point in time
What is the balance sheet/statement of financial position often referred to as and why?
‘snapshot’ of a firm’s financial position, indicates its financial health
What are assets?
possessions of a business that can be liquidated and have monetary value
Examples of assets
PP&E, stock, cash…
What are liabilities?
debts of a business
What are the 2 main things a statement of financial position must show?
- sources of finance (including liabilities and equity)
- uses of finance
Why is a balance sheet called a balance sheet?
a firm’s uses of finance must match its sources of finance
how should you call a balance sheet?
ALWAYS statement of financial position
non-current assets =
PP&E (property, plant and equipment) - accumulated depreciation
current assets =
cash + debtors + stock
total assets =
non-current assets + current assets
current liabilities =
bank overdraft + trade creditors + other short term loans
tip for remembering structure of statement of financial position
sandwich of current with a side of equity
non-current liabilities =
long term borrowings
total liabilities =
current liabilities + non-current liabilities
equity =
share capital + retained earnings
What are non-current assets?
long-term assets - fixed - that are not intended for sale in less than one year
What are current assets?
possessions of an organisation with a monetary value but intended to be liquidated in less than one year
3 ways that stocks can be categorised?
- raw materials
- work-in-progress
- finished goods
Examples of non-current liabilities
Bank loans
Mortgages
Corporate bonds
Debentures
What are mortgages?
long term loans used to purchase property, and so the property is used as collateral
What are corporate bonds?
debt securities sold to investors, represent a debt obligation that the borrower must repay with interest over a period
no ownership given
What are debentures?
long term loans issued by orgs. that borrow money from investors and repay it with interest, depends on borrower’s creditworthiness
What is depreciation?
the fall in value of a non-current asset
What causes depreciation?
wear and tear
new technologies (outdating)
What is the danger of not accounting for depreciation?
the firm’s non-current assets will be over-valued
What are the two methods of measuring depreciation?
the straight line method and the units of production method
What is the straight line method for accounting depreciation?
spreads depreciation evenly over the life of the asset
falls by equal amounts each year
How is depreciation recorded in the balance sheet?
net book value = original cost of asset - accumulated depreciation
Advantages of the straight line method
- easy to calculate
- suitable for assets with a known useful shelf life, can be estimated accurately
- suitable for assets with consistent usage rate
- easier to depreciate until scrap value is 0
- same amount charged to P&L: easy to make historical data comparisons
Disadvantages of the straight line method
- many assets depreciate most during beginning, can be inaccurate/misleading
- many assets don’t depreciate consistently
- not suitable if life span can’t be estimated accurately
- scrap values are only estimates - less accurate
What is the units of production method of depreciation?
depreciation of a non-current asset is based on each physical unit of output
calculates based on units of usage rather than time
How can you calculate depreciation per unit?
depreciation per unit = (cost of asset - scrap value)/estimated units of production
How can you calculate the depreciation expense?
depreciation per unit x actual units produced
Advantages of units of production depreciation
- for many, more accurate/realistic
- better for machinery/equipment
- more accurate for wear and tear rather than obsolence
- useful for fluctuations in production
Disadvantages of units of production depreciation
- more complicated to calculate
- subjectivity due to salvage value that can change
- subjectivity due to estimated units of production
- many tax authorities don’t allow units of production depreciation - used mainly for internal bookkeeping
What are the different types of intangible assets?
patents
copyright
registered trademark
goodwill
What is an intangible asset?
non-physical items of value owned by a company that have a lifespan of more than 1 year
