Theme 2 Knowledge to date

Question 1

Name 5 sources of finance?

Answer 1

Overdraft, Trade Credit, Retained profit in the form of cash reserves, Mortgage, Bank Loan, Selling Shares

Question 2

What is meant by unlimited liability?

Answer 2

If the business goes Bankrupt then any money awed to suppliers or the bank can be recovered through repossession of owners personal assets. This will only happen if the company does not have enough assets to cover the amounts owing

Question 3

Explain why a loan might not be appropriate for a business with unlimited liability

Answer 3

This will add further risk to the owners as it places pressure on the business to make regular payments which reduces cash reserves meaning that they may lack sufficient current assets to pay current liabilities risking liquidation which might then risk personal possessions.

Question 4

Explain how having unlimited liability impacts a business’ ability to gain credit from suppliers

Answer 4

If a business has unlimited liability it could work in their favour for getting credit from suppliers as the supplier will have the added security of collateral if the credit is not repaid. The supplier will know that they can recover any debt from the owners personal assets

Question 5

Why might banks be reluctant to provide a loan to a business with limited liability?

Answer 5

As if the business lacks sufficient assets to cover the cost of the loan then the bank will lose that capital as they can’t recover it from the owner’s personal possessions

Question 6

Explain the difference between an overdraft and a bank loan

Answer 6

An overdraft has a higher interest rate but is more flexible as the business can choose when they pay it off and by how much they pay off. However the bank can remove the overdraft at any time and ask the business for the amount owing. With a loan the repayments are fixed and the business must make regular monthly payments.

Question 7

What is the difference when a business uses share capital as a source of finance compared to using a venture capitalist?

Answer 7

A business needs to be a limited company to sell shares and will usually sell a small proportion of the business in one issue compared with raising money through a VC which involves giving up a significant part of the business (sometimes as much as 50%) in exchange for capital and advice/ experience. When a business issues shares the shareholders (particularly for a PLC) will probably have limited involvement in the business

Question 8

Explain why using retained profit as a source of finance may not be a favourable option for a PLC

Answer 8

If the business uses retained profit as a source of finance then the businesses share price may fall as it may mean that they reduce dividend payments which makes investing in the business (buying shares) less popular reducing demand for the shares and therefore reducing share price

Question 9

Explain how a business’ legal structure can have an impact on the source of finance a business chooses to use

Answer 9

If a business is a limited company they can issue shares and will attract more investors than a partnership and sole trader due to the reduced risk gained through limited liability status. Where as Partnerships and sole traders cannot sell shares and will struggle to attract investment due the unlimited liability status. Therefore they are more reliant on venture capitalists and loans.

Question 10

Identify three short term sources of finance

Answer 10

Overdraft, Trade Credit, Retained profit in the form of cash reserves

Question 11

Identify three long term sources of finance

Answer 11

Mortgage, Bank Loan, Selling Shares

Question 12

What is meant by working capital and why is it important when choosing a source of finance?

Answer 12

Working capital is the value of current assets that are left over after the current liabilities have been paid. If a business has high working capital it shows that it is at low risk of having cash flow problems and is therefore able to safely take out a loan as it is likely to keep up with loan repayments as it is likely to have sufficient cash in reserves. This reduced risk is recognised by banks and shareholders meaning they are willing to provide the capital. A low risk business will usually get a lower rate of interest on loans and be able to sell shares at a higher price.

Question 13

Why might a bank be more reluctant to lend money to a new restaurant than they are to other new businesses?

Answer 13

A restaurant is likely to provide luxury goods meaning that they are income elastic which means that sales could significantly fall if incomes fall due to changes in the economy. Therefore they are venerable to economic changes adding to the risk for the bank. If the country goes into a recession the business may struggle to pay the loan back.

Question 14

Why might an overdraft be an appropriate source of finance for a new business?

Answer 14

A new business will not have past sales data and will have limited experience in the market. Therefore it will be difficult to predict sales. Therefore it will be difficult to predict cash outflows like wages and cost of raw materials. Therefore they need flexible finance that they can use as and when required rather than committing to regular monthly repayments

Question 15

Why may a sales boom lead to the business going bankrupt?

Answer 15

To gain the sales boom the business may have overinvested into fixed assets such as vehicles and equipment causing significant cash outflows resulting in negative net cash flow making it difficult to keep up with payments to suppliers and banks. This may lead to the business being forced to sell fixed assets to the point that it can no longer function.

Question 16

Why might it be argued that a business should not keep large sums of cash?

Answer 16

There is an opportunity cost of keeping large sums of cash as this means the business it not fully utilising their capital as it could be making a greater return if invested in fixed assets. As the fixed assets such as a store or equipment could be increasing sales due to increased capacity. Or the capital could be invested in advertising or training of staff which would also increase sales - explain how

Question 17

Where can a new business go for capital if the bank says no and they don’t have any friends, family or savings?

Answer 17

venture capitalist - but the VA will know the high risk nature of a business like this and will want high returns so will request a large share of the business

Question 18

Why might a business be reluctant to take out an overdraft?

Answer 18

As there are significantly high interest payments. It can also be taken off them at a short notice which may mean the business will have to sell fixed assets in order to repay it

Question 19

Why might a business choose to buy equipment rather than lease it?

Answer 19

This will be better for long term cash flow as there will be will not be regular cash outflows

Question 20

Why might a business source finance using debt rather than equity?

Answer 20

So the business doesn’t have to give up shares so they can maintain complete control over the objectives of the organisation rather than having to consider potentially short term goals of shareholders

Question 21

What is meant by collateral and why is it important to a business?

Answer 21

Collateral is when a business places a fixed asset down as security for a loan. This says to the bank that if the loan is not paid they have legal ownership of the asset

Question 22

Why might suppliers refuse to give credit to a small company?

Answer 22

A small organisation might have few fixed assets therefore if they struggle to pay the supplier there is a risk that the supplier will not receive payment for the goods as there will be limited fixed assets that the business can sell to repay the debt

Question 23

Why do some companies pay dividend rather than keeping large amounts of retained profits?

Answer 23

When a business pays dividend it makes investments in the company more attractive to shareholders as they will gain an increased return on their investment. This will increase the demand for shares leading to an increase in share price. This will benefit the business as it will mean they can generate more capital from selling shares if they issue new shares leading to further expansion.

Question 24

I have a high interest rate and can be reduced or taken away with very little notice. What source of finance am I?

Answer 24

Overdraft

Question 25

Using this source of finance may have an opportunity cost

Answer 25

Cash reserves or retained profit

Question 26

I have to be secured against an asset

Answer 26

Mortgage

Question 27

I give up a percentage of ownership in return for investment and advice.

Answer 27

venture capitalist

Question 28

Using the internet I can attract a significant number of investors for small businesses

Answer 28

Crowed funding

Question 29

Explain why a business plan might be needed to secure finance for a new business

Answer 29

The business plan, if backed up by effective and reliable research (e.g. with large sample sizes and not prone to bias) the business plan can show the bank how the loan will be invested and how the business plans to repay the loan. The key section is the finance section that will show the cash flow forecast and if the closing balance can remain largely positive when paying off the loan then it is likely that the bank will view the lender as a lower risk. The business plan could be so convincing (especially if based on creditable research) that the bank may reduce the interest on the loan.

Question 30

Why might a business plan not be enough to secure finance from a bank?

Answer 30

Just because the business produces a business plan it does not guarantee them a loan as the plan might be based on inaccurate research or demonstrate poor cash flow. It could also illustrate that the business has a significant amount of competition with ineffective ways of dealing with the situation

Question 31

The shares of a private limited company cannot be bought and sold without the agreement of the other directors. Explain the benefit of this

Answer 31

This means that anyone who buys shares and becomes an owner is likely to share the same goals as the existing owners/directors. This could be a passion for the long term prospects for the business or a commitment to social and ethical objectives rather than a pursuit of short term goals and profit for dividends.

Question 32

“Without the legal protections of limited liability, economies would struggle to grow.” Explain why someone may agree with this statement.

Answer 32

The limited liability status means that investors are attracted to buying shares in businesses due to the reduced risk (there will be no chance that they could lose their personal possessions). This therefore increases the demand for shares leading to increased investment. Due to the increased investment businesses have more capital available to expand capacity which means they can produce more leading to an increase in GDP - economic growth

Question 33

Which part of a business plan is important to obtaining a bank loan and why?

Answer 33

The cash flow forecast as it shows the projected sales a business expects as well as a clear plan on how the loan repayments will affect their cash balance (closing balance) month to month

Question 34

What is a cash flow forecast and what are the main headings in one?

Answer 34

A cash flow forecasts shows projected inflows and outflows of a business over time (usually a year) and has the following headings: Inflows, Outflows, Net Cash Flow, Opening balance, Closing balance. Do you know how to work out net cash flow, opening balance and closing balance?

Question 35

How can cash flow forecasts be used to help a seasonal business?

Answer 35

The cash flow forecast, if based on accurate sales forecasts, will show the business when sales are expected to be low and identify when there may be a negative net cash flow. If a business knows this in advance they can possibly arrange an overdraft to ensure they can continue trading (pay day to day expenses). It may also alert the business to the fact that they may need to arrange trade credit with their supplier to help stockpile goods before the peak season. Showing the forecast and how the credit will be paid could help convince the supplier to give credit

Question 36

What should cash flow forecasts be supported by?

Answer 36

detailed market research so if that is primary research there needs to be a large sample size and the results need to be unbiased. Secondary research needs to also be reliable and relevant so must be based on the market or relate to a similar business

Question 37

How can cash flow forecasts be used to improve stock management?

Answer 37

The cash flow forecasts can show the business when sales should increase so they can order sufficient stock. It can also illustrate the implications of having too much stock as it will demonstrate the costs associated with storing stock such as insurance, rent and utilities

Question 38

Identify the key terms you should include in an answer to a question which requires you to assess the impact that a decision has on finance.

Answer 38

Cash, Liquidity, Profit, Profitability, costs, capital, equity, share price, assets, liabilities, dividends. NOT “INCREASE IN FINANCE”

Question 39

What is sales forecasting?

Answer 39

A sales forecast is an attempt by management to estimate the likely sales of a product, business unit or market over a future period.

Question 40

identify three factors that could cause inaccurate sales forecasting

Answer 40

New business with a lack of market knowledge of previous sales to extrapolate. Business that sells luxury goods (income elastic) a highly dynamic market. Market research that is based on a small sample size.

Question 41

Why are sales forecasts important to planning human resources?

Answer 41

If a business knows the sales that it could possibly achieve then it needs to means to achieve them. Therefore it needs the capacity, therefore it needs to recruit the right number of people. Or if sales are expected to fall then the business will need to reduce capacity so they will therefore need to plan redundancies. If there is expected to be a significant rise in sales in a new market then they may need to plan training or recruitment of employees so they have the capability of meeting needs in the new market

Question 42

What is meant by a trend and how is this useful to a business?

Answer 42

A trend is a pattern in sales data and it can be used to predict sales for the future by extrapolating the trend. Make sure you know why it is important for a business to know what sales are likely to do.

Question 43

State three economic variables that might affect the sales forecasts of a business

Answer 43

Inflation (having an impact on demand and costs), interest rates and exchange rates

Question 44

Why might it be easy for Heinz to forecast sales for its ketchup?

Answer 44

As the company has many years worth of sales data that it can analyse and identify a clear stable trend (sales generally remain the same from year to year) therefore they can carry out effective extrapolation resulting in reliable predictions

Question 45

What is meant by time series data?

Answer 45

A method that allows a business to predict future sales using past data

Question 46

What is meant by extrapolation?

Answer 46

Forecasting future trends based on past data

Question 47

What is meant by seasonal fluctuations?

Answer 47

This is when demand is determined by the time of year for example smaller quantities may be purchased in winter than summer

Question 48

What is meant by cyclical fluctuations?

Answer 48

This is when sales change as a result of changes in the economy (the business cycle).Recession, Recovery, Boom, Downturn (must know these to get this answer correct)

Question 49

What is a long term trend?

Answer 49

When a habit or behaviour shows little change over time. For example consumers like to watch TV on demand

Question 50

What is meant by a data range and how can it affect sales forecasting?

Answer 50

This is the amount of data that is available for analysis. If there is significant amount

Question 51

Identify 2 ways that sales can be measured

Answer 51

Value and Volume

Question 52

Give an example of a variable cost

Answer 52

Raw materials

Question 53

Give an example of a fixed cost

Answer 53

Rent, business rates (tax on buildings), Salaries, Utilities, advertising expenses

Question 54

Explain the difference between fixed and variable costs

Answer 54

Fixed costs don’t change when output changes and variable costs do change when output changes

Question 55

How do you work out average costs or unit costs?

Answer 55

All costs divided by the number of units

Question 56

What is the difference between sales volume and sales revenue?

Answer 56

Sales volume is the amount of units sold and revenue is the amount of money generated from these sales

Question 57

State three limitations of break-even analysis

Answer 57

Might be based on inaccurate data, does not account for economies of scale (see rest of text), only looks at data from one product. The costs could change which will change the break-even point meaning the decision to chose a particular product to produce may be based on inaccurate data. Costs may change due to change in the price of raw materials (variable costs) or change in the cost of rent (fixed cost). Also it does not account for purchasing economies of scale where variable costs should fall per unit as output increases.

Question 58

State three uses of break-even

Answer 58

Decision making tool: can help decide on which product to produce (the one with the lowest break-even point or the one that has the largest margin of safety when compared to sales forecasts). Can see the impact of a price change. Can see impact of a change in supplier. Can see impact of a change in production location

Question 59

What is the difference between a plan and a forecast?

Answer 59

A plan is based on what the business aims to achieve where as a forecast in based on what past and current data predicts will happen. A budget is a plan not a forecast

Question 60

How can budgets be used to motivate employees? What motivational theory could this be related to?

Answer 60

A budget can set targets for employees such as sales targets or cost targets (keep costs to a minimum) and of these are achieved then the employees can be given performance related pay which Taylor would argue is motivational. Could also be seen as a sense of achievement being felt when the targets are met which would meet esteem needs in Maslow’s theory.

Question 61

What is the equation for contribution per unit?

Answer 61

Selling price - variable cost

Question 62

What is meant by the term contribution?

Answer 62

It is the amount that is left over from sales once the variable costs have been covered. It is call contribution as the amount is used to contribute to the fixed costs until they are covered - broke even

Question 63

What is the equation for total contribution?

Answer 63

total sales revenue - total variable costs

Question 64

What is the equation for margin of safety?

Answer 64

total output - break-even point

Question 65

How can Break-Even be used to assess the impact of a price change?

Answer 65

A business can then calculate the new contribution per unit which can be used to calculate a new break-even point which will then change the margin of safety and show how likely the business is to avoid making or loss of how much profit they are likely to make by looking at the money generated between the break-even and the total output.

Question 66

How can a business reduce the break-even point?

Answer 66

Change premises (reduce fixed cost), make production more automated (reduced wages and therefore fixed costs), reduce waste relating to utilities (reduce fixed costs), change supplier or negotiate lower prices (reduce variable costs), change raw materials used in production (reduce variable costs), increase the selling price (increase CPU)

Question 67

How can businesses increase the margin of safety?

Answer 67

increase capacity to increase total output

Question 68

Why might a business have a high break- even point?

Answer 68

Low selling price, high fixed costs ( maybe paying high wages or located on the high street causing high rent) quality raw materials leading to high variable costs

Question 69

What impact can break-even point have on business objectives

Answer 69

If the business has a high break-even point and low sales forecast then they may set objectives relating to survival

Question 70

How might banks assess a businesses break even point?

Answer 70

A bank might look at the businesses break-even point and compare it to predicted sales to get an idea of the margin of safety and profit to see if the business is a high risk. If the business has a big margin of safety this might suggest low risk so the business may be more willing to loan money or reduce the interest rate

Question 71

What impact would a price increase have on the margin of safety?

Answer 71

Increase the margin of safety as contribution per unit would increase which would reduce the break-even point. However the expected output (sales) may have to reduce as a high price will lead to lower demand

Question 72

Why does a sales forecast need to be done before a business can know their margin of safety?

Answer 72

There is no point in basing the margin of safety on maximum capacity as the business might not have demand for that volume. This would result in over production and potentially wasted stock. Therefore the margin of safety should be based on predicted sales

Question 73

Explain how a collective bargaining approach can improve a business’ liquidity

Answer 73

If a business uses collective bargaining by consulting with trade unions relating to issues such as pay and working conditions then they are more likely to come to an agreement before strike action is taking which avoids down time in production. By avoiding downtime the business can ensure they maintain sales and therefore cash inflows avoiding liquidity issues

Question 74

What is meant by current liabilities

Answer 74

Money owed by the business in less than one year: overdraft, payables (amount owing to suppliers)

Question 75

Give two examples of non current liabilities

Answer 75

Mortgage and loans

Question 76

Explain how poor management of its working capital might affect a business

Answer 76

Management of working capital is related to managing credit predict periods given to customers and to suppliers. A business must ensure that the credit time they give customers is less or equal to when they receive from their suppliers. This ensures that they have regular and manageable inflows and outflows avoiding potential situations where they have a negative closing balance

Question 77

What is the difference between gross and operating profit?

Answer 77

Gross profit is sales revenue - cost of sales (just variable costs) where as operating profit is sales revenue - all operating expenses including fixed costs (fixed and variable)

Question 78

Which profit is directly affected by purchasing economies of scale?

Answer 78

Gross profit

Question 79

Which profit is directly affected by marketing economies of scale?

Answer 79

Operating profit

Question 80

Which type of profit considers everything?

Answer 80

Net profit - this takes account of sales of assets and one off purchases of assets

Question 81

Which type of profit is directly affected by variable costs?

Answer 81

Gross profit

Question 82

Which type of profit is directly affected by fixed costs?

Answer 82

Operating profit

Question 83

Identify three ways a business can improve profitability

Answer 83

Reduce costs without reducing sales revenue, increase selling price ( if price inelastic), increase sales volumes so average costs fall - economies of scale

Question 84

What is the difference between profit and profitability?

Answer 84

Profit is the total amount of money left from sales revenue after all costs haver been taken away. Profitability relates to how efficient the business is - it is not about having the highest profit it is about reducing costs to make the most of sales revenue. To increase profitability profit must rise by a greater proportion than sales revenue

Question 85

What is the difference between cash and profit?

Answer 85

Cash is money that is available to spend usually what is available in a business’ bank account. Where as profit is not necessarily available in the business it could have been given to shareholders as dividends or invested into fixed assets and is therefore not available to spend.

Question 86

Identify the key terms you should include in an answer to a question which requires you to assess the impact that a decision has on finance.

Answer 86

Cash, profit, assets, Break-even, contribution per unit, unit costs…NEVER SAY ‘AN INCREASE OR DECREASE IN FINANCE’

Question 87

Explain how inflation can have an impact on a business’ cost of sales

Answer 87

Inflation is the general rise in prices which suggests that the cost of raw materials will rise leading to an increase in the cost of sales

Question 88

What ratios can be calculated from the balance sheet?

Answer 88

Acid test, current ratio, gearing NOT profit ratios!!

Question 89

What ratios can be calculated from the income statement?

Answer 89

Gross profit margin, operating profit margin, Net profit margin

Question 90

How do you calculate gross profit margin?

Answer 90

Gross profit/ Sales revenue x100

Question 91

How might a business increase sales revenue by more than cost of sales?

Answer 91

by increasing the price

Question 92

Why might a high sales volume mean a business can have a low gross profit margin?

Answer 92

As although there may be small margins on each unit sold, if the business sells in large volumes they can significantly multiply that margin leading to a significant increase in gross profit

Question 93

Which marketing approach can have a low gross margin and why? Mass or Niche marketing

Answer 93

Mass as they sell in large volumes meaning that can have a low margin but high gross profit

Question 94

Why might a business have a lower gross margin than competitors?

Answer 94

They may have a lower selling price or higher raw material costs due to uncompetitive rates from their supplier

Question 95

What is meant by an exceptional items and which profit figure does it have an impact on?

Answer 95

A one off cost, purchase or sale that is not part of every day trading with their customers and suppliers. This may include the purchase or sale of a non-current asset

Question 96

What two equations can you use to assess a business’ liquidity and how do you calculate these equations?

Answer 96

Acid Test and Current Ratio and that is it

Question 97

Why is a business’ liquidity important? What is the line of analysis

Answer 97

If a business doesn’t have enough cash (poor liquidity) then they will not be able to pay suppliers or keep up with repayments on bank loans which may result in them having to sell fixed assets leading to major disruption to their business operations causing a fall in sales. If a business has lots of cash reserves and strong liquidity then they are able to demonstrate they are a low risk business as there is little chance they will be forced to liquidate fixed assets. Therefore they will be able to secure bank loans at lower rates of interest and will be able to sell shares at a higher price as due to the low risk their shares will be in high demand.

Question 98

Why might a business need to reduce capacity even if they have high capacity utilisation?

Answer 98

The business may be unable to pay suppliers or pay bank a bank loan so will need to sell fixed assets thus reducing capacity.

Question 99

What is meant by shareholders equity?

Answer 99

This is the amount of money that has been invested in the business from shareholders

Question 100

How can shareholder’s equity be utilised in a business?

Answer 100

usually kept as cash reserves or spent on non-current assets

Question 101

What is classed as good liquidity when looking at the results of liquidity ratios?

Answer 101

Current ratio needs to be between 1.5 and 2, acid test needs to be around 1

Question 102

Why might shareholders be unhappy if a business has above the ideal for liquidity ratios?

Answer 102

It may indicate that the business is not fulling utilising their equity as it is not invested in a productive asset such as machinery that could be making a return for shareholders. It may also suggest that the business is retaining too much of their net profits rather than paying dividends to shareholders resulting in a lower shareholder return

Question 103

Why might a high current ratio (above the ideal of 2) but a below ideal acid test ratio indicate ineffective financial management?

Answer 103

This may suggest that too much cash is tied up in stock which is an issue as that cash could be utilised more effectively such as investment in R&D or non current assets.

Question 104

What costs are associated with keeping high levels of stock and what profit does it have an impact on?

Answer 104

Insurance, rent, utilities (all for storage) leading to an increase in expenses and a fall in operating profit reducing ROCE

Question 105

What is meant by working capital?

Answer 105

The amount of current assets left over after all current liabilities have been paid

Question 106

What is the difference between a current asset and a non current asset?

Answer 106

Non-current assets is expected to be within the business for over a year and a current asset is expected be utilised in some form within the year. E.g. to pay off debts ( current liabilities for example)

Question 107

How can a business manage working capital effectively? Think about payables and receivables

Answer 107

A business can negotiate with suppliers so they have a longer credit period this giving them more time to cover current liabilities. If they manage to achieve this while reducing the credit period they give to their customers then they will have effective working capital management maximising cash reserves at a given time.

Question 108

How can a loan improve liquidity in the short term but damage it in the long term?

Answer 108

A loan will lead to a significant increase in cash in one go. This will increase current assets without increasing current liabilities. However over time the business will need to make repayments that will include interest. Loan repayments need to be made in cash which will reduce cash reserves over the long term

Question 109

How can sale and lease back improve liquidity

Answer 109

This will mean that the business gains an inflow of cash from the sale of equipment but it still able to use the asset

Question 110

What is meant by an intangible asset?

Answer 110

non-physical asset such as brand names and patents - is of value buy you can’t touch it

Question 111

Where will retained earnings appear on a balance sheet?

Answer 111

in the financed by section

Question 112

When can a business operate with a low current ratio and why?

Answer 112

Supplier power, cash sales

Question 113

A business purchases new machinery, funded entirely by a bank loan. Explain the impact that this will have on the balance sheet

Answer 113

There would be an increase in the value of fixed assets and an increase in the value of non current liabilities

Question 114

Explain the purpose of PESTLE analysis

Answer 114

To determine the external influences that may impact on a business. It considers a wide range of factors which businesses need to consider in their decision making

Question 115

Give 2 examples of political factors that might affect the food industry

Answer 115

Changes in taxation (eg. Sugar tax), government healthy eating initiatives (eg. ‘5 a day’), barriers to trade (eg. Increased difficulty of importing food from other countries due to potectionist policies)

Question 116

Give 2 examples of economic factors that might affect the holiday industry

Answer 116

Exchange rates (cheaper/more expensive to holiday abroad), interest rates (high interest rates means that customers have more incentive to save rather than sp[end their money), Unemployment (high unemployment may mean that people have less disposable income therefore spend less on holidays), inflation (high inflation may mean that customers have less disposable income if their wages have not increased at the same rate as prices for everyday goods. Costs for the holiday industry, such as jet fuel, may also have increased in price).

Question 117

Give 2 examples of technological factors that might affect the motor industry

Answer 117

New technology may mean that cars can be produced more cheaply/efficiently/quicker. Changes in technology have led to the production of more electric cars. New technology has enabled additional features eg. Keyless entry, to be added to cars