Theme 2 - Managing finance

Question 2

What is profit?

Answer 2

Profit is the difference between total revenue and total costs

Question 3

How do u work out the percentage change in profit?

Answer 3

Percentage change in profit = current years profit - previous years profit / previous years profit x 100

Question 4

What is gross profit?

Answer 4

Gross profit is the amount left over when the costs of sales is subtratced from total revenue. Cost of sales is the costs directly realted to making the product

Question 5

What is the calculation for gross profit?

Answer 5

Gross profit = total revenue - cost of sales

Question 6

What is operating profit?

Answer 6

Operating profit considers both the costs of sales and operating expenses such as administrative expenses. If a businesses gross profit is increasing but its operating profit is decreasing it usuaully means the business is not controlling

Question 7

What is the calculation for operating profit?

Answer 7

Operating profit = gross profit - other operating costs

Question 8

What is net profit?

Answer 8

Profit for the year ( net profit) takes into consideration the cost of any interest the business has to pay for borrowing money

Question 9

What is the calculation for net profit?

Answer 9

Net profit = operating profit - interest

Question 10

What is a statement of comprehensive income?

Answer 10

A statement of comprehensive income ( also known as a profit and loss account) shows how much money has been coming into the business ( revenue) and how much has been going out over a period of rime (expenses).

Question 11

How can a statement of comprehensive income be used?

Question 12

What is a profit margin?

Answer 12

Profit margin = measure the relationship between the profit made and the revenue. They tell you what percentage of the selling price if a product is actually profit

Question 13

What is profitablity?

Answer 13

Profitability = the amount of profit relative to revenue or investment

Question 14

What is gross profit margain?

Answer 14

The gross profit margin (GPM) measures gross profit as a percentage of revenue

GPM = gross profit / revenue x 100

• Depends on the business what counts as good GPM- higher percentage usually better
• GPM can be improved by increasing prices or reducing the direct cost of sales

Question 15

What is operating profit margain?

Answer 15

The operating profit margin ( OPM) takes into account all the costs of regular trading

OPM = operating profit/ revenue x 100

Question 16

What is net profit margain?

Answer 16

Net profit measures the profit for the year as a percentage of revenue

NPM = net profit/ revenue x 100

Question 17

What methods can businesses used to increase profit margains?

Answer 17

• Businesses can improve their profit margins by increasing their revenue- they could do this by increasing the prices, or reducing their prices to increase demand
• They could improve product quality which could lead to greater sales vokume and possibly a higher selling price, both of which could increase revenue
• Reducing costs of sales
• To increase OPM they could reduce operating expenses

Question 18

What is the difference between profit and cash?

Answer 18

Profit = is the money that a business has left from its revenue once costs have been paid

Cash = what a business has now to pay its bills. Cash is constantly flowing in and out of a business.

Question 19

What is a statement of financial position?

Answer 19

Statement of financial position can also be called balance sheets
They are a snapshot of a firms finances at a fixed point in time
They show the value of all the businesses assets ( things that velong to the business, including cash in the bank) and all its** liabilities ** ( the money the business owes)
They show all **the value of all the capital **(money invested into the business) and the source of that capital ( loans etc)

Question 20

What are current and non current assets?

Answer 20

**Current assets **are assets that the business is **likley to exhcange for cash within the accounting year, **before the nextstatement of financial position is made. All the current assets are added togehthee to give the **total current aseets value.
Current assets include recieveables, and invetory.

Non current assets are assets taht the business is likely to keep for more than a year ( property). The total non- current assets value is the combined value of all the businesses non current assets
- they often lose value overtime and this is called depreciation .

Question 21

What are current and non current liabilities?

Answer 21

Current liabilities = are debts wgich need to be paid off within a year. they include overdrafts, taxes due to be paid, payables ( money owed to creditors) and dividends due to be paid to shareholders. Total current liabilities are deducted from total non current and current assets to give the value of assets employed

Non current liabilities = are debts that the business will pay off over several years ( mortgages and loans)

Question 22

What are net assets?

Answer 22

The net assets value is the totatl fixed and current assets minus rotal current and non current liabilities

• It is always the same as the total equity value

Total equity= the total of all the money thats been put into the business

Question 23

What are net curremy assets

Answer 23

current assets- current liabilities

Question 24

What are retained profit?

Answer 24

Retained profit= value of money retained by the business and not given back to shareholders as dividends.

Question 25

What are bad debts?

Answer 25

Bad debts= debts that dont get paid and cant be included on the statement of financial position as an asset

Question 26

What is liqudity?

Answer 26

The liquidity of an asset is how easily it can be turned into cash and used to buy things

-Cash is very liquid, non current assets such as factories are not liquid, and inventory and money owned by debtors ( receivables) are in between
- A business that doesn’t have enough current assets to pay its liabilities when they are due is insolvent, either has to quickly find money to pay them o=, ask creditors if it can pay its debt over long period of time or go into liquidation ( cease trading and sell all of its assets to pay off its debts)
- Liquidity can be improved by decreasing stock levels, speeding up collection of debts owed to the business, or slowing down payments to creditors

Question 27

What is the calculation for current ratio? (liquidity ratio)

Answer 27

The current ration compares current assets to current liabilities

Current ration = current assets/ current liabilities

The current ratio should be higher than 1. 1.5-2 is considered ideal

• Much below 1.5 is considered a liqudity problem
• A value much higher than 2 suggests firm has more assets than it really needs

Question 28

What is acid test ratio? ( liquidity ratio)

Answer 28

The acid test ration is a tougher measure of liquidity than current ratio as it accounts for the inventory
Inventory can take a long time to sell or it might not sell at all- by removing inventory from current assets it gives a more accurate measure of the ability of the firm to pay its current liabilites

Acid test ratio= current assets- inventory / current liabilities

*Most businesses should have an acid ratio higher than 1

Question 29

What is working capital?

Answer 29

Working capital is the amount of cash ( and assets that can be easily turned into cash) that the business has avaliable to pay its day-day debts.

The more working capital a business has the more liquid it is.

Question 30

What is the calculation for working capital?

Answer 30

Working capital = current assets - current liabilities

Question 31

How much cash do businesses need?

Answer 31

Businesses need just enough cash to pay short term debts but they shouldn’t have too much cash
-spare cash is great at paying off debts but lousy at earning for the business

Question 32

What is business failure?

Answer 32

Business failure is when a business can no longer stay open because it isn’t making enough money to cover its costs. The business isn’t able to continue trading and shuts down while still owing people money.

• A business usually fails because it doesn’t have enough cash to pay current liabilities
• A businesses lack of cash ( and therefore failure) can be due to inside the business factors and outside the business, and these can be financial or non financial factors.

Question 33

What are internal financial factors that cause business failure?

Answer 33

-Bad management of working capitalcan cause business failure. This can result in a business not having enough cash avaliable to pay its day-day running costs such as paying suppliers and employees. If the business cant pay these costs it will quickly fail. A business needs to have accurate cash flow forecasting to make sure this doesnt happen
- Poor efficiency can lead to business failure.This is becayse a business with poor efficiency has costs that arent as low as they could be. This could man that they need to charge higher prices than their competitors to still make a profit, which could lead to them not generating the revenue needed to keep operating
- Bad decsions about how a firm is financed can lead to business failure. For example, a firm may rely on expensive forms of finsncr such as overdrafts in the long term meaning costs are very high. It may also take on too much debt at once and retain very little profit. If it needs more finance in the future to prevent it from failing it may find it very difficult to find a source of financr willing to lend it money at an affordable interest rate.

Question 34

What are internal non financial factors that cause business failure?

Answer 34

-Poor communication can result in business failure because it can mean that the different departments of the business arent working well together which reduces the efficiency of the business. It also means that messages about problems that arise and stratergies to fix them arent being passed on effectivley between managers and workers on different departments meaning they dont get resolved quickly.
- Inadequate market research and analysis means the business fails to monitor changes in the market that could effect it such as customers needs and preference. If a business doesnt sell products that people want to buy then there will be low demand for the products. May mean a lack of revenue and the business runs out of money that it needs to pay for expenses
- Marketing is used to drive demand for products. If marketing isnt done well ( at right time or strongly enough) then sales might not be high enough to generate sales revenue to cover businesses costs
- Failure to innovate can cause business failure. If a business fails to keep up with consumer preferencres by lacking innovative new products its likley to fail.

Question 35

What are external financial factors that cause business failure?

Answer 35

Economic recession can result in consumers having less money to spend. This can cause a fall in sales especially for luxury items ( items with positibe income elascity more than 1)
- A change in exchange rates can also have huge effects on demand for a firms product. If the pound strengthend then foreign firms exporting goods to the UK would offer cheaper prices than firms inside the UK. This would mean that the demand for imports would increase and would lead to a fall in demand for domestic goods. Also the demand for exports from the UK by other countries would decrease as it would be more expensive. This could lead to firms having to close if they couldn’t compete in long term with cheaper rivals or if they lost too many oversea customers

Question 36

What are external non financial factors that cause business failure?

Answer 36

The actions of competitors are a common cause of business failure. If competitors are able to offer a similar product at a lower price or develop new prodicys yjat are more desirable customers may choose the competitors. Cause firms sales to fall loss of revenue and business failure
- A change in consumer trends can lead to business failure, If customers suddenly stop wanting to buy a product then this will cause a sudden drop in revenue unless the business has a wide range of products and can react quickly.
- Poor communication outside of the business can cause failure. If business fails to communicate well with suppliers it could lose suppliers and may not be able to keep up production of products. Also if communication with customers is poor the business may get a bad reputation for poor customer service which may result in a loss of revenue and potentially business failure.

Question 37

How does the importance of these different causes of failure depend on businesses?

Answer 37

The factors that are most likley to cause a business to fail depends on lots of things such as the experience of owners, size of the business and the product and market its in.

• Businesses that operate in a dynamic market such as tech market, a lack of innovation can be a big cause of business failure
• For businesses that sell very price elastic products, economic changes increase the relative price of products and can have a big effect on demand
• Large and fast growing businesses are more likely to fail due to communication problems compared to smaller or slower growing firms

Question 38

What factors effect how much cash a business needs?

Answer 38

• A business with long working capital cycle needs more cash than a business with short working capital cycle ( has to wait for money to come in)
• Inflation increases the costs of wages and buying or holding stock, so businesses need more cash when inflation is igh
• When a business expands it needs more cash to avoid overtrading

Overtrading= means producing so much that the business cant afford to pay its suppliers until it gets paid by its customers

Question 39

What is the working capital cycle?

Answer 39

The working capital cycle= the length of time between buying raw materials and getting cash from sales of the finished product usually measured in days