Finance Flashcards
Define Overdraft
Where an individual can continue to withdraw money, even if there are no available funds.
Advantages of an Overdraft
- spend money you don’t have
- easy to set up
- good for unexpected costs
Disadvantages of Overdraft
- cannot be used for large borrowing
- very high interest rates
- bank can change the amount you can overdraw whenever they want
Define Loan
A fixed amount of borrowed money paid back in regular instalments.
Advantages of a Loan
- large amounts can be borrowed
- regular repayments can help plan cash flow
- good for large investments (e.g. machinery)
Disadvantages of a Loan
- have to pay interest rates
- must be paid back by specific date
Define Trade Credit
Business can purchase a product but does not have to pay for a set time period.
Advantages of Trade Credit
- no interest paid
- attain raw materials more easily
- encourages purchasing
Disadvantages of Trade Credit
- can face huge financial problems if not paid back
- can’t benefit from Economies of Scale
Define Factoring
A business sells its outstanding customer debts to a debt factoring company.
Advantages of Factoring
- raise finance quickly
- don’t have to chase debts
Disadvantages of Factoring
- reduces business’ overall profits as they receive less money from debt Factoring company.
Define Hire Purchase
A business hires equipment over a period of time, paying regular instalments; business owns asset after payments.
Advantages of Hire Purchase
- use the equipment whilst paying
- own the equipment after payments
Disadvantages of Hire Purchase
- huge interest rates
- costs more than buying outright
Define Leasing
A business hires equipment for a specific period of time, paying in regular instalments.
Advantages of Leasing
- can use the equipment, when you may not have been able to afford to purchase outright
- can be cheaper than buying outright
Disadvantages of Leasing
- huge interest rates
- don’t own it after payments
Define Debentures
A long term loan secured against a specific asset; repayable at a fixed rate.
Advantages of Debentures
- fixed rate so can help plan cash flows
Disadvantages of Debentures
- can take hold of assets if not paid
- interest may decrease but you still pay the same amount
Define Shares
Money invested into the business from shareholders.
Advantages of Shares
- once a shareholder makes an investment, the money belongs to the business
- spreads risk
Disadvantages of Shares
- have to pay investors dividends
- loose some ownership (but usually doesn’t affect businesses significantly)
Define Government Assistance
Where the government provides a business with a sum of money, usually in the form of a grant or subsidy.
Advantages of Government Assistance
- don’t have to pay it back
Disadvantages of Government Assistance
- have to spend on specific things (what the government provides it for)
- company must match amount given
Define Retained Profits
Profits kept by the business.
Advantages of Retained Profits
- you can do whatever you like with it
- no extra costs (like interest)
Disadvantages of Retained Profits
- once it’s gone, it’s gone
- limited amounts
What are the 8 Principles Of Accounting?
- Consistency (accounts produced uniformly)
- Going Concern (assumes operations are normal)
- Matching (dates show WHEN transaction occurs, not when payment is made)
- Materiality (value of business must be realistic)
- Objectivity (must remain realistic)
- Prudence (not overstating values)
- Realisation (things appear when transaction happens)
- Generally Accepted Accountancy Practice (GAAP, framework for accountancy)
How do you calculate PROFIT?
Profit = total revenue - total costs
How do you calculate REVENUE
Revenue = number of sales x price
How do you calculate TOTAL COSTS
Total costs = fixed costs + variable costs
Define Fixed Costs
Costs you pay regularly and that don’t change with output
E.g. insurance, rent.
Define Variable Costs
Costs that change with output
E.g. raw materials, wages.
What are MARGINAL COSTS and how do you calculate them?
A change in total costs due to increasing output by one unit.
marginal costs = change in total costs/change in output
Define Opportunity Costs
The cost of a decision; what has been lost by choosing a particular option (I.e. benefits of an alternative)
Define Social Costs
The total cost to the society/environment.
Define Direct Costs
Costs directly affected by production.
Define Indirect Costs
Costs that cannot be matched against each product because they need to be paid whether or not you produce.
How do you calculate UNIT (OR AVERAGE) COST?
Unit cost = total cost/number produced
Define Profit
Financial return or reward that businesses aim to achieve to reflect the risk that they take.
Define Margin of Safety
Difference between actual output and breakeven point, providing the actual output is greater than the break even point.
How do you calculate MARGIN OF SAFETY?
Margin of safety = sales - predicted sales
Define Breakeven Point
Where total revenue equals total costs.
How do you calculate BREAKEVEN POINT?
breakeven point = fixed costs/(price - variable costs)
How do you calculate CONTRIBUTION?
price - variable costs
Advantages of Breakeven Point
- gives the business a figure to aim for
- fairly realistic as it’s based on real figures
- help with decisions on prices or change in costs
- shows if it’s a viable proposition
- simple to do
Disadvantages of Breakeven Point
- sales are unlikely to be the same as output
- planning aid, not a decision making tool
- assumes you can sell all the products
- can only be used for one specific product
Define Standard Costs
The cost the business expects the production of a product or service to be.
Define Actual Cost
The actual cost of the production of a good or service.
Define Absorption Costing
A method of calculating the cost of a product by considering both indirect and direct costs.
Define Cost Centre
Part of an organisation to which costs may be charged for accountancy purposes (where they are calculated).
Define Profit Centre
A separately identifiable part of a business for which it is possible to identify revenues and costs.
Advantages of Cost Centres
- allow the business to manage and control money
- see which areas of the business are most profitable
- motivate employees responsible
- allows for supplier reviews (can we find cheaper suppliers?)
- allows for a review of the business’ efficiency
Disadvantages of Cost Centres
- may be difficult to allocate costs
- could cause extra pressure and stress on employees
- may be difficult to recognise whether the cost centre is running efficiently
- could have issues with collecting data
- some costs are hard to control
Advantages of Profit Centres
- useful insights to wheee Profit is earned within the business
- improve motivation of those responsible
- comparisons between departments can be made
- can identify revenue
Disadvantages of Profit Centres
- time consuming to set up and monitor
- may lead to interdepartmental completions/conflict
- could be demotivating if targets are too tough
- profit centres may pursue their own objectives
Advantages of Absorption Costing
- consideration of all costs when pricing decisions are made
- all costs are covered in the price of the good
- accurately shows a businesses profitability
- can allocate costs according to the importance of the product
Disadvantages of Absorption Costing
- can make managerial decisions difficult
- difficult to do if a business sells a variety of products at different prices and number of sales
Define Investment Appraisal
Where firms invest large amounts of money into capital stock.
Factors to consider before investing….
….- cost
- profitability
- demand
- the amount valuable to invest in
- the risk
- the payback time
- state of economy
- impacts on society
- size and type of business
- whether it’s necessary
- whether it’s relevant to business’ objectives
Define Payback Period
The time it takes for a project to repay its initial investment.
How do you calculate PAYBACK TIME?
Step 1: Identify expected revenues
Step 2: Add revenue to cumulative revenue for each year (see book)
Step 3: When the cumulative revenue is less than revenue, use this equation - cumulative revenue/revenue x 12.
Step 4: This gives you the months, always round UP.
Advantages of Payback Time
- simple and easy to calculate
- focuses on cash flow
- emphasises speed of return
- straightforward to compare with other projects
Disadvantages of Payback Time
- ignores cash flows that arise after payback ha sheen reached
- takes no account of the “time value of money”
- may encourage short term thinking
- ignores qualitative aspects of decision
- doesn’t create a decision for investment
Define Average Rate Of Return (ARR)
The average profit as a percentage of the cost of the investment.
How do you calculate ARR?
ARR(%) = ((total net profit/number of years)/initial cost) x 100
Advantages of ARR
- simple to calculate
- easy to compare with other projects
- looks at whole profitability
- isn’t limited to a time frame
Disadvantages of ARR
- doesn’t take into account the value of money overtime
- doesn’t consider cash flows
Define Net Present Value
Calculates the monetary value now of the project’s future cash flow (how much it will be worth in the future).
How do you calculate NET PRESENT VALUE?
Step 1: Multiply each expected revenue by expected rate of inflation.
Step 2: Add together he adjusted revenues.
Step 3: Subtract cost from the new adjusted total revenue.
Advantages of Net Present Value
- takes into account time value of money
- looks at all cash flows through the life of the project
- has decision making mechanisms
Disadvantages of Net Present Value
- difficult to calculate
- difficult to predict inflation
- very sensitive to initial investment costs
Define Budgeting
A detailed plan of income and expenses over a certain period of time.
Define Sales Budget
Shows the expected number of sales and income over a specific period.
Define Production Budget
Shows the expected costs of producing needed number of units.
Define Purchase Budget
Show the expected costs of raw materials needed to produce the product.
Define Zero Based Budget
All expense must be justified before a budget is allocated.
Define Fixed Budget
Budget doesn’t change when sales or other activities increase or decrease.
Define Flexible Budget
Budget adjusts to changes in sales or other activities.
What are the uses of budgets?
- help prevent overspending/reduce costs
- ensure each department receives enough and doesn’t spend too much
- motivate staff to be more efficient
Define Variance Analysis
A variance arises when there is a difference between actual and budget figures.
If sales are greater than predicted, the difference between budget and actual figures is…
…favourable
Reasons variances may be favourable
- costs were lower than expected
- revenue/profits were higher than expected
Reasons variance may be adverse
- costs were higher than expected
- revenue/profits were lower than expected
Define Cash Flow
The movement of cash into and out of a business.
How do you calculate NET CASH FLOW?
Net cash flow = total cash in - total cash out
How do you calculate CLOSING BALANCE?
Closing balance = net cash flow + opening balance
Main causes of cash flow problems
- low profits or losses
- over investment in capital
- too much stock
- allowing customers too long a credit period
- expanding too fast
- seasonal demand
Remedies for a poor cash flow
- cut costs
- cut stock levels
- delay payments to suppliers e.g. through Trade Credit
- reduce credit period offered to customers
- delay expansion plans
- improve working capital management
How do you calculate WORKING CAPITAL?
Working capital = current assets - current liabilities
Define Working Capital
The day-to-day money used by a business.
If current assets are more than current liabilities than…
…they can afford to pay their short term debts.
Define Liquidise
Sell (usually stock).
Define Current Ratio
An estimation of whether the business can pay debts due within one year, out of current assets.
How do you calculate CURRENT RATIO?
Current ratio = current assets/current liabilities
What is a good current ratio?
1.5-2:1
£1.50-£2 for every £1 owed
Define Acid Test Ratio
A more accurate estimate of whether the business can afford to pay their debts as it doesn’t include stock.
How do you calculate ACID TEST RATIO?
acid test ratio = (current assets - stocks)/current liabilities
What is a good acid test ratio?
1:1
A low ratio doesn’t necessarily mean it’s bad: Tesco’s is likely to have a very low acid test ratio but we know they sell their stock every day so debts will be paid.
Define Creditor Days
An estimation of the average time it takes a business to settle its debts with trade suppliers.
How do you calculate CREDITOR DAYS?
Creditor days = (Trade payables/cost of sales) x 365
Define Debtor Days
Focuses on the time it takes for trade debtors to settle their bills; indicates whether they are being given excess credit.
How do you calculate DEBTOR DAYS?
Debtor days = (trade debtors/revenue) x 365
Factors that affect the level of Working Capital
- some businesses have few debtors
- some businesses need to hold a lot of stock
- some businesses can negotiate longer credit periods
- some businesses do not received uniform income (seasonality)
Define Income Statement
A financial statement that shows income and expenditure over the course of a year.
What 3 things happen to profit?
- Tax is paid
- Dividends are paid
- Rest is retained
Define Gross Profit Margin
How much in every one pound of sales is gross profit.
How do you calculate GROSS PROFIT MARGIN?
gross profit margin = (gross profit/sales revenue) x 100
Define Net Profit Margin
How much of every one pound the business actually keeps as profit.
How do you calculate NET PROFIT MARGIN?
net profit margin =(net profit/sales revenue) x 100
Define return on capital employed
How much of every £1 a business gets back from what they invested.
How do you calculate RETURN ON CAPITAL EMPLOYED?
return on capital employed = operating profit/capital employed x100
Define Capital Employed
Money invested in machinery.
Define Return On Equity
How much profit is made per £1 of shares.
How do you calculate Return On Equity?
return on equity = net profit/equity x 100
equity refers to share capital
Define Efficiency/Activity Ratios
Shows how well the business manages its assets and liabilities.
Define Non-current Asset Turnover
For every £1 spent on fixed assets, the business gets however much the fixed asset generates.
Define Stock Turnover
How many times they use all of their stocks in a year.
How do you calculate a STOCK TURNOVER?
stock turnover = cost of sales/stock
Define Gearing Ratio
Measures what proportion of money invested is from long term borrowing (e.g. loans).
How do you calculate GEARING RATIO?
gearing = long term liabilities/capital employed x 100
Highly geared =
Over 50%
