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Higher Business > Finance > Flashcards

Finance Flashcards

1
Q

The Role of Finance

To monitor cash flow

A

Organisations need to be aware of how much money is going in and going out. There has to be enough “cash” available to pay suppliers, creditors and employee wages.
Making profit and having good cash flow are two different things.

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2
Q

The Role of Finance

To control costs and expenses

A

Financial problems may arise when costs and expenses are not monitored closely. Wherever possible, the need to borrow money to meet these costs should be avoided. Management may need to take action to reduce costs (money leaving the business).

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3
Q

The Role of Finance

To forecast what might happen in the future

A

Preparing budgets and looking at past financial records can help identify trends and see what might happen in the future. It also identifies if action should be taken to help prevent potential financial problems.

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4
Q

The Role of Finance

To monitor performance

A

Financial information can be used to compare one years performance against the previous year. This is useful in deciding if action taken in the past has proved beneficial and, where necessary, where to take action in the future. Ratio analysis can also be used.

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5
Q

The Role of Finance

To provide information for decision making

A

Financial information plays a crucial role in decision making and will often influence which course of action is taken.

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6
Q

Sources of Finance

Bank Overdraft

A

This allows an organisation to withdraw more money than available.

ADVANTAGES
-Quick and easy to set up.


DISADVANTAGES

  • Usually only for a short period of time.
  • Daily charges and/or interest may apply.
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7
Q

Sources of Finance

Trade Credit

A

This allows an organisation an extended period of time to pay for purchases.




ADVANTAGES
-Can sell products and receive money before paying for materials.

DISADVANTAGES
-Credit is at suppliers discretion – not always guaranteed.

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8
Q

Sources of Finance

Retained Profit

A

This is a portion of the previous years profits which can be reinvested into the organisation.

ADVANTAGES
-Belongs to the organisation


DISADVANTAGES
-Relying on profits can be risky as profit may not always be available.

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9
Q

Sources of Finance

Government Grant

A

This is given to a new organisation to help them start up.




ADVANTAGES
-Does not have to be repaid.

DISADVANTAGES
-Usually only a one off payment.

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10
Q

Sources of Finance

Bank Loan

A

This is a sum of money from the bank to be repaid over an agreed period of time.

ADVANTAGES

  • Quick and easy to set up
  • Can be repaid over a long period of time.


DISADVANTAGES
-Interest can be expensive.

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11
Q

Sources of Finance

Share Issue

A

Extra shares are sold to new or existing shareholders.




ADVANTAGES

  • Large amounts of capital can be obtained.
  • It is not repaid in the same way as a loan.

DISADVANTAGES

  • Dilutes existing share value
  • Share issues can be expensive
  • The selling price of shares varies daily.
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12
Q

Sources of Finance

Hire Purchase

A

This allows an organisation to buy an item but pay for it over a period of time.

ADVANTAGES
-Can receive item immediately without full payment.


DISADVANTAGES

  • Could have high interest.
  • Item is not owned until fully paid.
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13
Q

Sources of Finance

Mortgage

A

This is a loan given specially to purchase land or property.




ADVANTAGES
-Taken over a long period of time eg. 25 years.

DISADVANTAGES
-Interest rates may change which affects repayments.

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14
Q

Sources of Finance

Leasing

A

This allows an organisation to rent equipment or premises rather than buy it.

ADVANTAGES

  • Improved cash flow as no expensive purchases.
  • Equipment can be changed regularly.

DISADVANTAGES

  • The leased items are not owned therefore are not assets.
  • Leasing over long periods may prove to be more expensive.
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15
Q

Sources of Finance

Venture Capital

A

This provides a large loan to an organisation with bad credit. Usually the VC will part-own the organisation in return for taking a risk.




ADVANTAGES

  • Organisations with poor credit ratings are considered.
  • Large amounts of finance obtained.

DISADVANTAGES
-Not suitable for small amounts of money or short term.
-Can be expensive.



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16
Q

Sources of Finance

Stock Market

A

This is where shares are traded in PLCs.

  • Share price is determined by the supply and demand of the shares.
  • The more attractive a share is, the more expensive it will be.
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17
Q

Cash flow

A

Cash is a vital resource for an organisation. It is needed to run the business on a day-to-day basis, from achieving long-term objectives to paying staff wages. 

It is important that an organisation monitors its cash flow – making a profit and having good cash flow are two different things.

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18
Q

Poor cash flow

A

Do they have too much money in stock?
Are sales generating enough money?
Are they giving customers a long credit period?
Is the credit period from suppliers not long enough?
Significant increase in operating expenses?
Are they paying high dividends?
Have they purchased assets recently?

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19
Q

How to improve cash flow

Introduce a JIT stock management system

A

This will prevent money being tied up in stock as it is ordered only when needed

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20
Q

How to improve cash flow

Offers discounts to customers as an incentive to pay on time

A

This will encourage quick payment from customers so money can be used to fund other activities

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21
Q

How to improve cash flow

Sell any fixed assets that are no longer required

A

This will generate money quickly and easily, and will not impact production

22
Q

How to improve cash flow

Increase promotional activities

A

This will increase awareness of products, could increase sales and therefore cash flow

23
Q

Cash Budgets

Receipts (in)
Payments (out)

A

Cash Budgets give a forecast of the money expected to be received (receipts) and the money expected to be paid out (payments) over a given period of time.

Organisations manage cash and ensure control over cash flow.

Departments often aim to work within a given budget – this responsibility will lie with the dept. manager

24
Q

Benefits of using Cash Budgets

A
  • It shows whether the business will have a surplus (more cash in than out) or deficit (more cash out than in)
  • It shows whether additional finance is required to ensure the business continues operating effectively
  • It helps control expenses by highlighting periods when expenses could be high
  • It helps to make decisions eg. Whether or not to launch into a new product area
  • It measures performance of departments.
25
Q

Income Statement

A

The Income Statement shows money which has came in and gone out of the organisation over the past financial year.
Money made from buying and selling is known as the GROSS PROFIT.
Once expenses have been deducted, this is
NET PROFIT.

26
Q

Statement of Financial Position

A

A Statement of Financial Position shows the worth of an organisations at one given point in time.

ASSETS to the organisations are items they own.

LIABILITIES of an organisation are debts they have to pay.

27
Q

Non- current asset

A

Something that a business owns. Usually used on a daily basis and has a degree of permanence. These include premises, machinery and vehicles.

28
Q

Current asset

A

Something that is owned, but will hopefully be converted into cash in the short term. This can include stock to be sold or cash in the bank.

29
Q

Current liability

A

A short term debt. Something that is going to have to be paid within a year.

30
Q

Non- current liability

A

A debt that is not due for repayment imminently (a year or more).

31
Q

Equity

A

Money invested by the owners to set it up. This is classed as a liability. The owners are owed this by the business.

32
Q

Net assets employed

A

Difference in value between the total assets and the total current liabilities. Assets should total more than current liabilities.

33
Q

Reserves

A

Money / profits retained by the business to perhaps buy new assets or protect against future losses.

34
Q

Net assets

A

The financial value or worth of a business.

35
Q

Stakeholders interest in financial information

Employees

A
  • To check whether they are being paid fairly based on the profit being made
  • To get a better understanding of recent decisions (redundancies)
36
Q

Stakeholders interest in financial information

Shareholders

A
  • To decide whether or not to purchase additional shares

- To check whether they are being paid a fair dividend based on the profit being made

37
Q

Stakeholders interest in financial information

Suppliers/Creditors

A
  • To decide whether or not to allow the organisation more credit
  • To give a good indication of the organisations ability to pay off debts
38
Q

Stakeholders interest in financial information

Lenders

A
  • To determine whether or not a loan should be given

- To give a good indication of the organisations ability to pay off debts

39
Q 
Stakeholders interest in financial information 
Inland Revenue (HMRC)
A

-To check that the organisation is paying the correct amount of tax

40
Q

Accounting Ratios

A
  • Used as a tool in decision-making process and as an aid financial interpretation and planning
  • They may be used by managers within the business as well as outsiders who are interested in the performance of the business or who have an interest in the business.
41
Q

Accounting Ratios

Types

A

Profitability
-Shows how profitable (or not) the organisation is.

Liquidity
-Shows the organisations ability to pay its short-term debts.

Efficiency
-Shows how financially efficient and effective the organisation is.

42
Q

Accounting Ratios

Uses

A
  • Compare current performance with previous years.
  • Measure Profitability
  • Compare similar sized organisations in similar industry.
  • Measure an organisations efficiency
  • Highlight Trends
  • Show if an organisation has the ability to pay short-term debts
43
Q

Accounting Ratios

Limitations

A
  • The accounting information used to calculate the ratios is historic, i.e. it is based on information that is out of date.
  • When comparisons are made with other businesses the comparison is only valid where the business is of the same type and size and the same information is available to calculate the same ratios.
  • Comparisons with other businesses can be difficult as many businesses publish only very limited financial information.
  • Comparisons must be made using the same ratio calculations – many businesses ‘tweak’ the ratio formulas to better suit their own needs.
  • Comparisons of ratios with different businesses in the same sector may be meaningless if the ratios are not calculated on the same basis, i.e. using the same formula.
44
Q

Profitability Ratios
Gross Profit %:

Gross Profit x 100
Sales revenue

This ratio shows the profit made from buying and selling stock.
The higher the % the better.

A

An INCREASE in the ratio from one year to the next could mean:

  • Selling price has been raised
  • Cost of sales have been reduced. This could have been because a cheaper supplier has been found.
  • Increased promotion has caused demand to increase.
  • Competitive advantage

A DECREASE in the ratio from one year to the next could mean:

  • It has cost us more to produce the item for sale.
  • Demand dropped through inefficient marketing.
  • Inventory lost through wastage or theft.
  • More competition in the market.
45
Q

Profitability Ratios
Profit for the year %:

Profit for the year x 100
Sales revenue

This ratio shows the profit made once expenses have been deducted.
The higher the % the better.

A

An INCREASE in the ratio from one year to the next could mean:

  • More money has been received through sales (gross profit increased)
  • Cheaper alternatives have been found in regards to expenses (cheaper electricity supplier).

A DECREASE in the ratio from one year to the next could mean:

  • Gross profit has decreased
  • Expenses have increased. We should be looking for cheaper alternatives.
46
Q

Profitability Ratios
Return on Equity Employed:

This ratio shows the return that the owner or shareholders have on the investment that they have made.

If in year 1 the ratio was 17% this would mean that a return of 17p has been made for every pound that has been invested. This does not include any dividend payments.

A

An INCREASE in the ratio from one year to the next could mean:

  • Revenue has increased (see gross profit ratio reasoning)
  • We have lowered expenses.

A DECREASE in the ratio from one year to the next could mean:

  • Revenue has decreased (see gross profit ratio reasons)
  • Expenses have increased. We should be looking for cheaper alternatives.
47
Q

Liquidity Ratios
Current ratio:

Current Assets : 1
Current Liabilities

The current ratio shows how able an organisation is to pay its short term debts. Current assets should be able to be turned into cash quickly.

A

An ideal ratio is 2:1.
This would mean the organisation has double the amount of current assets than current liabilities.

If ratio < 2:1, the organisation would struggle to pay its short-term debts.
If ratio > 2:1, the organisation would consider ways to decrease this to ensure resources are used in the most effective way.

48
Q

Liquidity Ratios
Acid test ratio:

(Current Assets-Inventory) : 1
Current Liabilities

This ratio shows the ability of a business to pay its short term debts without having to sell Inventory. Inventory is removed as it cannot be guaranteed that it can be sold off quickly enough to generate cash to meet debts.

1:1 is generally regarded as being acceptable.

A

An INCREASE in the ratio from one year to the next could mean:

  • Current liabilities have decreased (we have fewer creditors)
  • We have increased our current assets by having more money in the bank.

A DECREASE in the ratio from one year to the next could mean:

  • We have increased our current liabilities (more trade receivables)
  • Our current assets have decreased ( less money in the bank).
49
Q

Efficiency Ratios
Rate of Inventory Turnover Ratio:

Cost of Sales
Average Inventory

Average Stock is Closing Inventory + Opening Inventory /2

This measures the length of time that inventory is held within a business. If inventory is held for too long, this may suggest that inventory levels are too high and an alternative inventory system needs to be implemented such as JIT.

A

An INCREASE in the ratio from one year to the next could mean:

  • Cost of sales has increased
  • Decrease in average inventory holding.

A DECREASE in the ratio from one year to the next could mean:

  • Decrease in cost of sales
  • Increase in average inventory holding
50
Q

Efficiency Ratios
Trade Payables Period:

Average Trade Payables x 365
Credit Purchases

A

This measures the number of days (or weeks or months) it takes the business to pay its credit accounts.

Normal credit terms are usually around 30 days so we would expect the figure to be around this number of days.

If businesses have a substantially higher number of days for this ration, it can indicated a cash-flow problem or difficulty in paying short-term debts.

51
Q

Efficiency Ratios
Trade receivables period:

Average trade receivables x 365
Credit sales

A

Measures the number of days (or weeks/months) it takes the business to receive money from its credit accounts.

Normal credits are around 30 days.

Where the businesses have a substantially higher number of days, it can indicate a cash-flow problem or difficult in chasing outstanding accounts from its customers.

Higher Business (3 decks)

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