Finance Flashcards
What is meant by Sources of Finance?
Where a business gets the money it needs from
What are some examples of businesses spending its finance?
- Equiptment
- Research + Development
- Wages
- Buying Stock
- Maintenance
- Tax
- Survival
- Expansion
What do we classify as short term?
Up to 3 years
What do we classify as medium term?
3-10 years
What do we classify as long term?
Over 10 years
Internal Sources of Finance - What is Divestment?
Close down a part of the business to free up more money to direct it elsewhere
Internal Sources of Finance - What are Personal Savings?
Owner puts their own money into the business
Internal Sources of Finance - What does Sale/Lease back mean?
Sell an asset and you leased it back from the owner
Internal Sources of Finance - What does Factoring mean?
Where you sell the debt
Internal Sources of Finance - What does retained profit mean?
Using spare profits from last year for current investment
Internal Sources of Finance - What is sale of fixed assets?
Sell land, cars, buildings etc
Advantages of using personal savings for finance.
- You know exactly how much money is available (short term)
- More Control
Disadvantages of using Personal Savings for finance.
- Strains family and personal life
- Lose personal Possessions
Advantages of using Sale / Lease back for finance
- Release cash from existing items (long term)
- Can be cheaper than other methods
Disadvantages of using Sale/Lease back for finance
- Asset is no longer under ownership of that company
Advantages of using Factoring for finance
- Improves cash flow quickly (short term)
Disadvantages of using Factoring for finance
- Reduction in the scope for other borrowing
- Lost money as part of debt
Advantages of using Retained Profit for finance
- Cheap (short term)
- Quickly provide funds
Disadvantages of using Retained Profits for finance
- Shareholder criticism
Advantages of using Sale of Fixed Assets for finance
- Fast Money
- Extra space
Disadvantages of using Sale of Fixed Assets for finance
- Asset Sales don’t sell that well
- Taxes can apply
Advantages of using Divestment for finance
Improves cash flow
What are Accounting Concepts?
Things businesses accounts should do when making a balance sheet
What are the Accounting Concepts?
- Consistency (using the same method for the balance)
- Going concern (Business is assumed to be running normally when doing the accounts)
- Matching (produce the accounts at the same time)
- Materiality (when producing accounts the figures should be realistic)
- Objectivity (Trying to remove opinions)
- Prudence (were judgement is need you are conservative)
- Realisation (publish the accounts on the same day)
What is an Income Statement?
Is a financial statement that shows if a business has a profit or a loss
What is the Gross Profit Equation?
Sales - Cost of Sales = Gross Profit
What is the Net Profit Equation?
Gross Profit - Expenses/Overheads = Net Profit
What does the balance sheet show?
Shows the performance of a business in one moment of time
What does Liquidity mean?
The ability to turn fixed assets into cash
What are the 3 types of stock?
- Raw materials
- Work in progress (most stock is this)
- Finished Products
What do Income Statements show?
Over a period of time wether a business has made a profit or a loss
An asset is something you […….]
OWN
A Liability is something you […….]
OWE
Fixed assets are things you can use [……..]
Again and again
When looking at [……..] we are looking at the ability to pay off short term debt.
Liquidity
What can Working Capital also be called?
Net Current Assets
What is Working Capital
/Net Current Assets?
Money used for the day to day running of business
What are Current Assets?
Things you own in the short term
What are Current Liabilities?
Things you owe NOW
What is the Working Capital Equation?
Working Capital = Current Assets - Current Liability
What is the Current Ratio Equation?
Current Assets / Current Liabilities
What is the Return on Capital Employed (ROCE) Equation?
( Profit before tax and interest / Long term capital employed ) x 100
What is the Gross Profit Margin Equation?
( Gross Profit / Turnover ) x 100
What is the Net Profit Margin Equation?
( Net Profit / Turnover ) x 100
What is the Return of Equity Equation?
( Net Profit / Equity )
What equations are Profitability equations?
- Return on Capital Employed (ROCE)
- Gross Profit Margin
- Net Profit Margin
- Return on Equity
What are the Liquidity Ratios?
- Current Ratios
- Acid Test Ratio
- Gearing Ratio
- Interest Cover
What is the Current Ratio Equation?
Current Assets / Current Liabilities
What is the Acid Test Ratio?
Current Assets - ( Stock / Current Liabilities )
What is the Gearing Ratio?
( Fixed Cost Capital / Long Term Capital ) x 100
What is the Interest Cover Equation?
( Profit before Tax and Interest / Interest
What is the Average Rate of Return Equation?
Average Profit / Capital Outlay
What is Capital Outlay?
Is the money firm uses to purchase fixed assets ( they are also known as Capital Expenditures )
What is the Average Profit Equation?
Profit / Number of years
What is the Payback equation?
( Remaining to pay / Revenue ) x 12
What does Payback mean?
How long it takes you to payback the cost of the machine
What is the Benefit of Payback?
- Simple and easy to calculate
Drawbacks of Payback?
- Doesn’t tells you how easy it is to get the money in the first place
- Doesn’t tell you how long the investment will last
- Based on assumptions
How is Profit Expressed?
As a % of the investment
What is the Profit Calculation?
( Average yearly profit / Initial Investment ) x 100
What is another Profit calculation?
Total money made - Investment
What is the average profit equation?
Profit / Number of Years
How do you calculate the average rate of Return?
Average Profit / Investment
What are the Advantages of Average Rate of Return?
- % Return can be compared with a target return
- Focuses on profitability a key issue for shareholders
What is the disadvantages for Average Rate of Return?
- Does not take into account cash flows, only profits
- Takes no account of the time value of money (inflation)
- Treats profits arising late in the project in the same way as those which might arise early
Does Net Present Value take into account inflation?
Yes
What are the Benefits is Net Present Value?
- Takes inflation into account
- Provides a real judgement on investment
What are the Disadvantages of Net Present Value?
- Overly optimistic returns
- Difficulty Working Out discount rate
- Other issues may arise over its lifetime
Current Assets is what you won in the [………] term
Short
Current Liabilities are things you owe [……..]
Now
What is the Working Capital Equation?
Current Assets - Current Liability
What is the Current Ratio?
Current Assets / Current Liabilities
What is the optimum values for current ratio?
2:1
Is it bad if the current asset is a lot greater than the Current Liabilities? And why? (Current Ratio)
Bad - because you may be holding lots of stock, lots of debtors
What would a Current Ratio of 1.5:1 or 2:1 suggest?
Efficient management of working capital
What does a Current Ratio of below 1 indicate?
Cash problems
What does a High Current Ratio indicate?
Cash problems
What is the Acid Test Ratio Equation?
( Current Assets - Stock ) / Current Liabilities
What is the best value for the Acid Test Ratio?
1:1
What does the Acid Test Ratio show?
A companies ability to pay its Current Liabilities with its Quick Assets (quick Assets are Assets that can be sold for cash within 90 days)
What is the Debtor Collection Period Equation?
( Debtors / Turnover ) x 365
What does Turnover also mean?
Revenue
What is Debtors Collection Period measured in?
Days
What does Debtors Collection Period measure?
Measures how long it takes debtors to pay back
With Debtor Collection Period what do you do if your answer is a decimal?
Always Round UP
For Debtors Collection Period what is the ideal Value?
28/30 working days is the benchmark
What is the Creditor Payments Equation?
( Creditors / Cost of Sales ) x 365
What is Creditor Payments Measured in?
Days
What does Credit Payments measure?
Measures how quickly a business can pay a debt
What is the difference between Debtors Collection Period and Creditor Payments?
Debtor Collection Period - you can see how long it takes a business to get payed
Creditor Payments shows how fast a business can pay suppliers
Examples of External Sources of Finance.0
- Overdraft
- Trade Credit
- Leasing
- Hire Purchasing
- Bank Liam
- Grant
- Share Issue
- Mortgage
- Venture Capital
What is an Overdraft?
Drawing more money out than the bank account holds
What is Trade Credit?
Buy now pay later
What is Leasing?
Don’t own the asset but pay for the right to use it
What is Hire Purchasing?
Paying for something you use in regular instalments
What is a Bank Loan?
Money the banks lends out with interest
What is a Grant?
A sum of money given by the government to another organisation for a particular purpose
What is a Share Issues?
When a company gives shares out to potential investors
What is a Mortgage?
Agreements that allows you to borrow money from a bank in order to buy property
What is a Venture Capital?
Financing that investors provide to start up companies
What Finance is used in this Example - Business needs £250,000 to buy a new factory.
Mortgage
What Finance is used in this Example - The new owners will revise £50,000 but wants 25% of the company?
Venture Capitalist
What Finance is used in this Example - A business needs £1 million to expand into Asia
Loan
What Finance is used in this Example - the business needs to keep its Cash Flow good every month
Trade Credit
What Finance is used in this Example - the business can get a sum of money specifically for Solar Panel Energy.
Grant
What Finance is used in this Example - the business wants flexibility with the equipment they use.
Lease
What Finance is used in this Example - a Sole reader needs £25,000 for new machinery.9
Loan
What Finance is used in this Example - a business wants to pay for its cars in instalments and eventually own them.
Hire Purchasing
What Finance is used in this Example - the business needs finance for a few days to pay for stock
Trade Credit
True or False - a loan is usually repaid with interest
True
True or False - Shareholders Are part owners of the business
True
True or False - banks will always lend a business money
False
True or False - venture capitalists are easy to attract
False
True or False - an overdraft is a long term source of finance?
False
True or False - a Mortgage can be used to buy equipment and machinery
False
True or False - Leasing gives you flexibility to change in the future
True
True or False - app businesses have lots of cash available
False
Advantages of Bank Loans?
- Bank doesn’t take an ownership position in the company
- No more obligations to the lender once payed off
Bank loan disadvantages
- Difficult to obtain without a suitable reputation
- High Interest Rates
Advantages of a venture capitalist
- Free to make fast investment decisions
- acres to investors knowledge m
Disadvantages of venture capitalist
- takes longer to find a suitable investor
- requires giving up a date of a company
Advantages of a grant?
- can provide huge investments
Grant disadvantages
- very hard to get
- must be spent in what is is intended to be spent on
Leasing advantages
- lease startup costs are lower than buying
- flexible
Leasing disadvantages
- more expensive than outright purchasing
- Depend In landlord maintainance
Mortgage advantages
- Keep ownership of premises
- Fixed Interest option
Mortgage disadvantages
- need a large deposit
- less flexible when premises is owned not leased
Factors that influence the choice of what external source of finance to use.
- Time
- Legal Structure
- Security
- External issues (economy as a whole)
What does Quantitative mean?
How much will it cost us (Debt)
What does Qualitative mean?
Do we lose some control? (% of the business)
What does the Current Ratio show?
How much you have to how much you owe
What is the Gross Profit Margin Formula?
Margin(%) = (Gross Profit) / (Sales Revenue) X 100
What is the Net Profit Margin Formula?
Net Profit Margin = (Net Profit [before tax]) / (Sales) X 100
What is Net Profit Margin the same as?
Gross Profit Margin
Sales is the same as what?
Revenue
What is the Operating Profit Margin Equation?
(Operating Profit) / (Sales) X 100
What is Operating Profit?
Is when they haven’t taken off financial expenses such as: Tax, Inflation etc
What is the Return of Capital Employed (ROCE) Equation?
Operating Profit / Capital Employed X 100
What is ROCE expressed as?
As a %
What does Return of Capital Employed show us?
Shows the return for every £1 invested
What are Net assets?
What you payed for
What is Equity Shareholder Funds?
How you pay for it
What is the Return o Equity Equation?
Profit for the year / Shareholder Equity
What does the Return on Equity Equation show us?
Shows us how much you are making for every £1 invested
What is the Gearing Equation?
(Loans) / (Shares + RP + Loans) X 100
What does a Gearing Ratio show us?
Shows how much money in the business has to be payed back as a loan
What value is bad in a Gearing Ratio?
A value close to 100%
Gearing Ratios - Anything over 50% is said to be [………………]
Highly Geared
Gearing Ratios - Anything below 50% is said to be [……………………..]
Low geared
What is the Interest Cover Equation?
(Operating Profit) / (Interest Payable)
What does Interest Cover show us?
Shows is there is enough Profit to pay the interest
What does the Interest Value mean?
Shows how many times over profit can pay interest
What is the best value for Interest Cover?
The higher the value the better
What is the Non-Current Asset Turnover Ratio?
(Revenue) / (Non-Current Assets)
Why are Current Assets called Current Assets?
because they change regularly
What is the Net Asset calculation?
All Assets - All Liabilities
What can Fixed Assets be called?
Non-Current Assets
What does the Non Current Asset Turnover show us?
Shows us for every £1 invested on machinery it creates (…..) revenue
What is the best value for Non Current Asset Turnover?
The bigger the value the better
What is the Stock Turnover equation?
(Cost of Sales) / (Average Stock Held)
What does Stock Turnover show us?
Shows how many times over you sell over your current stock in a year.
What does the Stock Turnover depend on?
On the type of business
How do you calculate how long it takes to sell your current stock?
365 / (Stock Turnover Figure)
What value is good for Stock Turnover?
Higher the value the better
Evaluative points for Stock Turnover.
- Low number suggests problems with stock control
- Seasonal fluctuations in demand
What is the Dividend per Share Equation?
(Total Dividends Paid) / (Number of ordinary share in issue)
What is dividend per share measured in??
£
What is the Dividend Yield equation?
(Dividend per share [pence]) / (Share price [pence])
What is Yield?
Is the return as a percentage of the value
What is the Yield for this? A - £200 bought with £20 Fixed interest
B - First bought for £400 with £20 Fixed interest
A - 10% interest (yield)
B - 5% interest (yield)
Evaluative Points for Dividend Yield?
- Annual yield be compared with:
> Other companies in the same sector
> Rates of return on alternative investments - Shareholders look at dividend yield when deciding to invest
- Usually high yield might suggest an under-valued share price
What is the Earnings Per Share (EPS) equation?
(Profit for the year) / (Number of Shares Issued)
What does the earnings per share show us?
Shows how much profit each share has earned over the past year.
What is the Price Earnings Ratio?
(Per market share price) / (Earnings per Share)
What does Price Earnings ratio measure?
Measures the confidence about what the shares will earn
What does a Price Earnings Ratio of 10 show?
Means the market price is 10x the earnings of that shares will earn
What is the Average Profit Equation?
Profit / Time period
What is Payback
Is how long it takes to pay back an initial investment
What is a Budget?
Is allocating a set amount of money each month for various expenses
What is Variance?
Where there is a difference between planned budget and actual outcome of the budget (what you think will happen eventually does)
What is Positive Variance?
We underspend on our planned expenditure
What is Negative Variance?
We overspend on our planned expenditure
What is the Closing Balance equation?
Opening Balance - Total Balance
What is Zero Budgeting?
Is the process of creating a budget from nothing without using prior years budget or spending numbers
How does overspending on this years budget affect next years budget?
Take it off next years budget
How are budgets used for cash flow forecasting?
Given o people or departments
How do you Improve Cash Flow?
- New products
- Put Prices up
- Spread Costs
3 short term sources of finance?
- Trade Credit
- Overdraft
- Owner uses their own money
What are the benefits of producing a cash flow forecast?
- Helps to set targets for management
- Cash Flow is vital for survival
- It spots problems in advance and allows solutions to get put in place
What are the Limitations is a Cash Flow Forecast?
- Can be affected by external factors being experienced by the company
- Limited Information (estimates)
- Uncertain business environment ( business environment may be different tomorrow than it is today)
What is meant by owners drawings?
Taking out money from the business for yourself
What is Investment Appraisal?
Is how a business decides if an investment project is worthwhile
What are some advantages of Payback?
- Simple to calculate
What is the ARR calculation?
(Average annual accounting profit) / (Initial Investment) x 100
What are the three steps to work out ARR?
- Total Revenue - Total Costs = Profit
- Total Profit / Time Period = Average Profit
- Average Profit / Initial Cost. X 100 = ARR
What are the Advantages of Investment Appraisal?
- Simple to apply
- Helpful to analyse cash flow problems
Disadvantages of Investment Appraisal?
- Ignores all cash flows after payback period
- Only includes Initial Cost of the machine
What are the advantages of Average Rate of Return? (ARR)
- Focuses on Profit rather than Payback
- Easy to compare different investment projects
Disadvantages of Average Rate of Return?
- Does not take into account the timing of cash flows
- If ores the value of money (Inflation)
What are the advantages of ROCE?
- Good for evaluating the performance of the whole business
- Easy to calculate
Disadvantages of ROCE?
- Not a good method for Appraising investment in capital projects
- Generally used for past data rather than future projects
Disadvantages of NPV/Discounted Cash Flow?
- Difficult to calculate
- Not accurate if initial outlay on projects is considerably different
What are the Advantages of NPV/Discounted Cash Flow?
- Takes into account time and interest rates
- Returns from different investment options so can be easily compared.
