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Business > Unit 5 > Flashcards

Unit 5 Flashcards

1
Q

Why do businesses need finance?

A
  • To set up the business (start-up capital).
  • To pay working capital.
  • To purchase buildings and non-current (fixed) assets.
  • Capital expenditure.
  • To finance expansion of the business.
  • To finance research into new products and/or new markets.
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2
Q

What is start-up capital?

A

The capital needed by an entrepreneur when first starting a business.

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3
Q

What are non-current (fixed) assets?

A

Resources owned by a business which will be used for a period longer than one year, for example buildings and machinery.

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4
Q

What is capital expenditure?

A

Spending by a business on non-current assets such as machinery and buildings.

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5
Q

What is short-term finance?

A

Loans or debt that a business expects to pay back within one year.

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6
Q

What are long-term finance?

A

Debt or equity used to finance the purchase of non-current assets or finance expansion plans. Long-term debt is borrowing a business does not expect to repay in less than five years.

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7
Q

What kind of businesses are the main sources of finance suitable for?

A

Limited companies.

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8
Q

Why are they not suitable for sole traders and partnerships?

A
  • Cannot raise capital through the sale of shares.
  • Usually only need to finance small capital expenditure projects.
  • Are often considered by lenders to be too high risk for large scale borrowing.
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9
Q

How can businesses fund their activities?

A
  • Internal finance.
  • External finance.
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10
Q

What are internal sources of finance?

A

This is capital which can be raised from within the business itself.

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11
Q

What are examples of internal sources of finance?

A
  • Owner’s savings.
  • Retained profits.
  • Sale of non-current assets such as equipment and machinery.
  • Some of the business’s working capital.
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12
Q

What is retained profit?

A

Profit remaining after all expenses, tax and dividends have been paid and which is ploughed back into the business.

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13
Q

What usually happens with retained profits?

A

Usually, owners receive part of the profits as dividends and the rest is reinvested back to business itself.

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14
Q

What are some advantages of retained profit?

A

There is no cost to the business. The profits have been earned through its trading activities.

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15
Q

What are some limitations of retained profit?

A

It is only available when the business is profitable.

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16
Q

What is the sale of non-current (fixed) assets?

A

It is another possible source of internal finance.

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17
Q

How do businesses carry out the sale of non-current (fixed) assets?

A
  • Sale of unwanted current assets.
  • Sale and leaseback of non-current assets, for example selling land and buildings owned by the business and then renting them back to the owner.
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18
Q

What are some advantages of selling non-current (fixed) assets?

A
  • There is no direct cost to the business.
  • It can often raise large amounts of money.
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19
Q

What are some disadvantages of selling non-current (fixed) assets?

A
  • Future fixed costs of the business will increase as they now have to pay annual leasing charges to the new owner.
  • Leasing charges are likely to increase each time the lease is renewed.
  • When the leasing agreement comes to an end the business may have to find new premises if the new owner decides that they want to use the land or buildings for other purposes.
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20
Q

What does the use of working capital refer to?

A

Businesses may be able to use some of their working capital to raise additional funds.

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21
Q

How may some sources of finance come from the use of working capital?

A
  • Cash balances.
  • Reducing inventory levels.
  • Reducing trade receivables (debtors).
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22
Q

What are cash balances?

A

Any cash a business has can be used to finance capital expenditure.

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23
Q

What does the business have to ensure that they have when using cash balances?

A

That they have enough cash to finance their day-to-day expenses, short term debts and any unexpected expenditure. Otherwise, this could threaten the survival of the business.

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24
Q

What is reducing inventory levels?

A

The business may decide to reduce the quantity of raw materials and components of finished goods it holds.

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25
Q

What is reducing trade (or accounts) receivables?

A

Most businesses sell goods to customers on credit so they are expected to pay on an agreed date in the future.

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26
Q

Why is this an effective source of finance?

A

The business’ cash balances increase and this provides a possible source of internal funds for capital expenditure.

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27
Q

Why cant you reduce working capital?

A

It is risky because it may reduce the businesses’ liquidity and its availability to pay short-term debts.

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28
Q

What are external sources of finance?

A

This is capital raised from outside the business.

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29
Q

How are external sources of finance divided?

A
  • Long-term sources.
  • Short-term sources.
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30
Q

What are examples of short-term finance (less than 1 year)?

A
  • Overdraft.
  • Trade credit.
  • Debt factoring.
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31
Q

What is an overdraft?

A

An agreement with the bank which allows a business to spend more money that it has on its account up to an agreed limit. The loan has to be repaid within 12 months. They are usually used to meet short-term cash shortages.

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32
Q

What are some advantages of an overdraft?

A

Businesses are able to change the amount of borrowing a short notice depending on their needs.

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33
Q

What are some limitations of an overdraft?

A

The cost of this type of borrowing is often higher than most other sources of borrowing.

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34
Q

What is trade credit?

A

It is a source of finance as the supplier is really lending the money for the cost of the goods for the length of the agreed credit period.

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35
Q

What are advantages of trade credit?

A
  • If a business can negotiate longer credit terms with suppliers it will increase short-term finance.
  • The business can delay the payment to the supplier.
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36
Q

What are limitations of trade credit?

A
  • Any discount offered by the supplier for prompt or early payment will be lost.
  • The supplier may refuse further deliveries to the business until the outstanding payment has been made.
  • If delayed payment occurs too often, then the supplier may demand payment before delivery.
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37
Q

What is debt factoring?

A

The amount owed to a business by its customers who bought goods on trade credit.

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38
Q

What happens if a business gives its customers a longer period of time to pay their debt off?

A

The greater the amount of finance it will need to find from other sources to be able to meet day-to-day expenses and other short-term debts.

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39
Q

How do you debt factor?

A

You sell the debt to a debt-factoring company.

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40
Q

What are advantages of debt factoring?

A

The business will be provided with immediate cash.

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41
Q

What are trade receivables?

A

Amount owed to a business by its customers who bought goods on credit.

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42
Q

What are examples of long-term sources of finance?

A
  • Bank loan
  • Hire purchase
  • Leasing
  • Mortgage
  • Debenture
  • Share issue
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43
Q

What is a bank loan?

A

It is a provision of finance by a bank which the business will repay with interest over an agreed period of time.

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44
Q

What are some advantages of bank loans?

A
  • Easy and quick to access
  • Can get a significant amount of money at one time
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45
Q

What are some disadvantages of bank loans?

A
  • Have to pay interest
  • Difficult for a new business to access as the bank doesn’t have trust in smaller businesses.
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46
Q

What is leasing?

A

Obtaining the use of a non-current assets by paying a fixed amount per time period for fixed period of time. Ownership remains with the leasing company.

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47
Q

What are some advantages of leasing?

A
  • No large upfront payments
  • Leasing company may be responsible for repairs and maintenance
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48
Q

What are some disadvantages of leasing?

A
  • Over time it can be a more expensive way to obtain assets
  • Assets aren’t owned by the business
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49
Q

What is hire purchase?

A

The purchase of an asset by paying a fixed repayment amount per time period over an agreed period of time. The asset is owned by the purchasing company on completion of the final payment.

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50
Q

What are some advantages of hire purchase?

A

Expensive assets can be purchased and paid back over time

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51
Q

What are some disadvantages of hire purchase?

A
  • Interest is charged on hire purchase items
  • Equipment is not owned until the final payment is made
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52
Q

What is a mortgage?

A

A long-term loan used for the purchase of land or buildings.

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53
Q

How is interest charged on a mortgage?

A

It is charged on the amount borrowed and this must be paid each year.

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54
Q

What is a debenture?

A

A bond issued by a company to raise long-term finance usually at a fixed rate of interest.

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55
Q

What is a share issue?

A

A source of permanent capital available to limited liability companies.

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56
Q

What are advantages of share issues?

A
  • Can gain lots of money quickly
  • No interest payable
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57
Q

What are disadvantages of share issues?

A
  • Give away part of the business
  • Leaves a business open to takeovers
  • Shareholders receive dividends
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58
Q

What is equity financing?

A

Permanent finance provided by the owners of a limited company.

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59
Q

What are advantages of equity financing?

A
  • It never has to be repaid.
  • There is no ongoing cost. If the business makes a loss it does not have to pay dividends to shareholders.
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60
Q

What are disadvantages of equity financing?

A

The increase in shareholders ‘dilutes’ the ownership of the company. Producing a prospectus to offer the shares for sale is expensive.

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61
Q

What are government grants?

A

A sum of money provided by the government to a business that does not have to be repaid.

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62
Q

What are some advantages of government grants?

A
  • Does not need to be paid back
  • Available to small businesses
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63
Q

What are some disadvantages of government grants?

A
  • Business needs to meet certain criteria
  • It is time-consuming to apply for grants and to complete the paperwork
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64
Q

What is micro-finance?

A

Small amounts of capital loaned to entrepreneurs in countries where business finance is often difficult to obtain. These loans are usually repaid after a relatively short period of time.

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65
Q

What is crowd-funding?

A

Financing a business idea by obtaining small amounts of capital from a large number of people, most often using the internet and social media networks.

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66
Q

What are some advantages of crowd-funding?

A
  • It acts as a form of market research. If people don’t invest, it means the business idea is not attractive or distinctive enough, indicating that the business is likely to fail.
  • It provides opportunities for individuals to start up a business even if they don’t have access to other sources of funding.
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67
Q

What are some disadvantages of crowd-funding?

A
  • The business must be interesting. Crowdfunding is most successful when the business idea is appealing, interesting and innovative.
  • It can be difficult to reach the funding target. Statistics from crowdfunding websites indicate that less than 33 per cent of businesses achieve their funding target.
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68
Q

What are some factors that influence the choice of finance?

A
  • Size and legal form of business.
  • Amount required.
  • Length of time.
  • Existing borrowing.
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69
Q

Why is cash to important to a business?

A

Without cash, a business will fail.

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70
Q

Why would the business fail?

A

It wouldn’t be able to pay:
- Its employees’ wages.
- Its suppliers for goods and services.
- Rent, heating and lighting and other costs for its premises.

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71
Q

What is a cash-flow forecast?

A

An estimate of the future cash inflows and cash outflows of a business.

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72
Q

What does a cash flow forecast provide to the business?

A

To enable businesses to identify any future time periods when cash shortages may occur.

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73
Q

What is the net cash flow?

A

Cash inflow - Cash outflow.

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74
Q

What should a business aim to have in terms of cash flows?

A

A positive cash flow.

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75
Q

Why is a positive cash flow so important?

A

As any temporary cash shortage may cause problems for the business and result in an increase in borrowing costs.

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76
Q

How do business prevent a negative cash inflow?

A

They need an accurate forecast of the size and timing of cash inflows and outflows.

77
Q

What is an example of net cash flow?

A

10,000 cash inflow. 7,000 cash outflow.
Net cash flow = 10,000 - 7,000
= 3,000

78
Q

What does the closing balance in the cash-flow forecast show?

A

How much cash the business expects to have at the end of each month

79
Q

What happens if the closing balance is negative?

A

Then this tells management that the business will have a cash shortage.

80
Q

How do you find out the opening balance of the next month?

A

The closing balance of the most recent month.

81
Q

How can a business increase its cash inflows?

A
  • Ask trade receivables to pay for goods more quickly by offering discounts to customers who have been sold goods on credit.
  • Negotiate longer credit terms with suppliers.
  • Delay the purchase of non-current assets until the cash flow improves.
  • Find other sources of finance for the purchase of non-current assets.
82
Q

What measures the liquidity of a business?

A

Its working capital.

83
Q

What is working capital?

A

The capital needed to finance the day-to-day running expenses and pay the short-term debts of a business.

84
Q

What is liquidity?

A

The ability of a business to pay its short-term debts.

85
Q

What does it mean in terms of liquidity if a business doesn’t have enough liquidity?

A

The business will be illiquid.

86
Q

What is the working capital cycle?

A

The relationship between the time it takes from buying raw materials, making these into goods for sale, finding buyers for the finished goods and then receiving payments from customers.

87
Q

What does the length of the working capital cycle depend on?

A
  • The level of inventories held by a business and how quickly suppliers are paid.
  • How long it takes to produce goods for sale.
  • How quickly the business finds buyers for its products.
  • The length of the credit period customers are given - credit sales.
88
Q

What are credit sales?

A

Goods sold to customers who will pay for these at an agreed date in the future.

89
Q

How can a business improve its woking capital?

A
  • Reducing inventory levels.
  • Negotiating longer credit terms with its suppliers.
  • Reducing the amount of time it takes to receive payments from customers who have been supplied goods on credit terms.
90
Q

What is profit?

A

Profit is the difference between revenue and total costs.

91
Q

What are the three types of profit?

A
  • Gross profit.
  • Profit.
  • Retained profit.
92
Q

What is gross profit?

A

The difference between the revenue earned from selling products and the cost of making those products.

93
Q

What is the equation for gross profit?

A

Gross profit = revenue - cost of sales.

94
Q

What is profit?

A

The difference between the revenue from sales and total costs or the difference between gross profit and expenses.

95
Q

What is the equation for profit?

A

Profit = revenue - total costs.

96
Q

What is retained profit?

A

The owners of a profitable business may decide to reinvest some of the profits in the business.

97
Q

How do businesses make profit?

A

By selling its products to customers at a price which is higher than the total cost of making and supplying those products.

98
Q

What is the total cost?

A

Cost of sales + expenses.

99
Q

What is revenue?

A

The amount earned by a business from the sale of its products,

100
Q

What is the formula for revenue?

A

Revenue = selling price x quantity sold.

101
Q

What can the total costs to a business supplying its goods and services be divided into?

A
  • Cost of sales.
  • Expenses.
102
Q

What are cost of sales?

A

The cost of purchasing the goods used to make the products sold.

103
Q

What are expenses?

A

Day - to - day operating expenses of a business.

104
Q

What is another equation for profit when you are provided with values for gross profit and expenses?

A

Profit = gross profit - expenses.

105
Q

What kind of reward is profit?

A

A reward to business owners for the risk they take in investing their capital into the business.

106
Q

What is profit used for?

A
  • To measure the success of a business.
  • To measure the performance of managers.
  • To decide whether or not to continue making or selling a product.
  • To finance the purchase of non-current assets, expand the business, and so on.
  • Attract investors who will provide the additional funds needed to finance business expansion.
107
Q

What usually happens to businesses in relation to their profit and cash?

A

Many new businesses make a profit, but they do not survive very long because they don’t manage their cash well.

108
Q

What are some differences between cash and profit?

A
  • Money invested in a business, or borrowed by a business, increases cash but doesn’t increase profit.
  • Capital expenditure, such as buying a new machine, decreases cash but doesn’t decrease profit.
  • Sales of goods on credit are recorded in the income statement as soon as the goods have been sold. This increases profit but cash doesn’t increase until the buyer pays for the goods.
109
Q

What pays for the day to day expenses?

A

Cash, and it is important for the business at all times.

110
Q

Where is cash stored?

A

At the bank.

111
Q

When is profit important?

A

It is more important for the long-term success of the business.

112
Q

What is an income statement?

A

A financial statement which records the revenue, costs, and profits of a business for a given period of time.

113
Q

When must an income statement be produces by a business?

A

At least once a year.

114
Q

How do owners/ shareholders use income statements?

A

Profit after tax belongs to them. They can see how much they have earned for their investment in the business.

115
Q

How do shareholders use income statements?

A
  • Usually the higher the profit, the higher the dividend payment.
  • The market value of shares will often rise or fall depending on whether high or low profits earned.
116
Q

How do employees use income statements?

A
  • High profit increases job security.
  • Employees might expect to receive a good pay rise if a business is making good levels of profit.
  • Some businesses have profit sharing schemes, so high profit means high share of profits for employees.
117
Q

How do lenders use income statements?

A
  • They want to be sure that profit is enough to pay interest on loans.
  • Is the business earning enough profit to be able to repay loans when due?
118
Q

How does the government use income statements?

A

The higher the profit, the more tax the government will receive.

119
Q

How do suppliers use income statements?

A

A firm that is profitable will continue to purchase raw materials and other supplies. This helps suppliers to earn profits.

120
Q

How do managers use income statements?

A
  • They can compare profit from one year to the next, or with competitors’ profits, to measure the performance of the business.
  • Retained profit is an important source of finance for a business.
121
Q

What is a statement of financial position?

A

An accounting statement that records the assets, liabilities and owners equity of a business at a particular date.

122
Q

What are assets?

A

Resources that are owned by a business.

123
Q

What are liabilities?

A

Debts of a business that will have to be payed sometime in the future.

124
Q

When must the business produce a statement of financial position?

A

At the end of each financial year.

125
Q

What are non current (fixed) assets?

A

They are resources that a business owns and expects to use for more than one year.

126
Q

What are some examples of fixed assets?

A
  • Land
  • Buildings
  • Machinery
  • Computers
  • Motor vehicles
127
Q

What are current assets?

A

Resources that the business owns and expects to convert into cash before the date of the next statement of financial position.

128
Q

What are some examples of current assets?

A
  • Inventory
  • Trade receivables
  • Cash
129
Q

What are trade receivables?

A

The amount of money owed to the business by customers who have been sold goods on credit.

130
Q

Why are current assets important to a business?

A

Because they are an important source of liability.

131
Q

What can the liabilities be divided into?

A
  • Current liabilities.
  • Non-current (longterm) liabilities.
  • Owners equity
132
Q

What are current liabilities?

A

They are the debts of the business which it expects to pay before the date of the next statement of financial position.

133
Q

What are some examples of current liabilities?

A
  • Trade payables.
  • Bank overdraft.
  • Taxation.
  • Dividends.
134
Q

What are trade payables?

A

The amount a business owed to its suppliers for goods bought on credit.

135
Q

What are non-current (longterm) liabilities?

A

Debts of the business which will be payable after more than one year.

136
Q

What are some examples of non-current (longterm) liabilities?

A
  • Long-term bank loans.
  • Mortgages.
  • Debentures.
137
Q

What is owners equity?

A

The amount owed by the business to its owners; includes capital and retained profits.

138
Q

What can owners equity be known as?

A
  • Shareholders’ equity
  • Shareholders’ funds
139
Q

What is shareholders equity / funds?

A

Alternative term for owners equity, but can only be used by limited liability companies.

140
Q

What does a statement of financial position show?

A
  • The assets the business owns.
  • What the business is owed.
  • What the business owes.
  • How the business finances its activities.
141
Q

Why is the statement of financial position not a reliable measure of how much a business is worth?

A

It provides only a mere snapshot of a businesses’ financial position at a particular point in time - the date of the statement, and the individual figures can change a lot in a short space of time.

142
Q

What benefit does checking a businesses performance regularly provide?

A
  • Identify its strengths and weaknesses so that it can decide which, if any, of its policies or strategies needs to be changed.
  • Show whether the business is meeting its objectives.
  • Improve further business performance.
143
Q

What does the profit a business earns say about it if its in the private sector?

A

Since its main objective is to make profit, profitability is an important indicator of how well a business is performing.

144
Q

How can information on income statements and statements of financial position be analysed?

A

Using:
- Profitability ratios.
- Liquidity ratios.

145
Q

What are the three ways of analysis of accounts that we can use for profitability?

A
  • Gross profit margin.
  • Profit margin.
  • Return On Capital Employed.
146
Q

What is the gross profit margin?

A

It shows profit as a percentage of revenue.

147
Q

What is the equation for the gross profit margin?

A

Gross profit margin = gross profit
————— x100
revenue

148
Q

What can a business do if it wants to increase its gross profit margin?

A
  • Increasing revenue without a similar increase in cost of sales: this may be achieved through an increase in price.
  • Reducing cost of sales without a similar decrease in revenue: this can be achieved by buying cheaper supplies.
149
Q

What is the profit margin?

A

It shows profit as a percentage of revenue.

150
Q

What is the equation for the profit margin?

A

PM = profit
———- x100
revenue

151
Q

What is another equation for profit?

A

Profit =
revenue - (cost of sales + expenses)

152
Q

What can the profit margin and gross profit margin show?

A

How well the business adds value and controls cost.

153
Q

What does adding value mean?

A

Selling a product for more than it cost to produce it.

154
Q

What does an improvement of the gross profit margin from one year to the next indicate?

A

Improved added value.

155
Q

What does it mean if a business has a higher gross profit margin than a competitor?

A

The business has achieved higher added value for its products than its competitors.

156
Q

What is the Return Of Capital Employed?

A

The ratio shows profit before tax as a percentage of capital employed.

157
Q

What is capital employed?

A

It is the amount invested in the business by the owners.

158
Q

What is the equation for the ROCE?

A

ROCE = profit
———————– x100
capital employed

159
Q

What do you have to do with the ROCE for it to be of use?

A

Compare it with the ROCE results from previous years, or with similar businesses.

160
Q

What does it mean if the business has a higher ROCE than that of its competitors?

A

The businesses profitability has improved or its better than similar firms in the industry.

161
Q

What is liquidity?

A

A business access to cash.

162
Q

How can we monitor a business’ liquidity?

A
  • Current ratio.
  • Acid test ratio.
163
Q

What is the current ratio?

A

It shows the ratio between current assets and current liabilities.

164
Q

What is the equation for the current ratio?

A

Current ratio = current assets
————————-
current liabilities

165
Q

How can we tell if the business risks liquidity problems?

A

If the level of current assets isn’t greater than those of current liabilities.

166
Q

What is further analysis of this?

A

There is not enough cash coming into the business to pay its short-term liabilities and have spare cash for unexpected expenses.

167
Q

What should the current ratio be higher than?

A

1.5:1. Otherwise there is a risk of running out of cash.

168
Q

What should the current ratio not be higher than?

A

2:1. As this suggests that the business has too much cash tied up in unprofitable assets.

169
Q

What is the problem with using the current ratio as a measure of liquidity?

A

Some assets are more difficult to turn into cash than others.

170
Q

What is the acid test ratio?

A

It is the ratio between liquid assets and current liabilities.

171
Q

Why are inventories the least liquid of current assets?

A
  • The finished goods inventories have to be sold.
  • When they are sold on credit, the customer has to wait for them to pay.
172
Q

What is special about the acid test ratio?

A

It excludes inventories from current assets and shows the most liquid current assets as a ratio instead. So, the acid test ratio is often considered to be a better measure of a business’ liquidity.

173
Q

What is the equation for the acid test ratio?

A

Acid test ratio =
(current assets - inventories)
——————————————
Current liabilities

174
Q

What does an acid test ratio of 1:1 mean>

A

It is satisfactory. If the value is lower than that then there is a risk of the business not having enough cash to pay its short-term liabilities. If it is too high then cash is being tied up in unprofitable assets.

175
Q

What does a business need in order to pay its debts?

A

Liquidity.

176
Q

What must it not do when paying its debts?

A

It must not keep large amounts of cash which could’ve been used for profitability.

177
Q

What do those assets which increase a businesses profitability do to its liquidity?

A

It does not improve its liquidity.

178
Q

How are current assets which increase a businesses liquidity do its its profitability?

A

It doesn’t improve profitability.

179
Q

How can a business therefore ensure its long-term survival?

A

By maintaining a balance between the need for profitability and the need for liquidity.

179
Q

What are the benefits of ratio analysis?

A
  • Users can compare ratios overtime, and identify trends.
  • Users can compare results with similar businesses to see how well the business is doing against competitors.
  • Users can easily identify important information such as profitability and the liquidity without having to look at all of the financial statements.
180
Q

What are the limitations of ratio analysis?

A
  • Ratios compare past data. Users of accounts - stakeholders - are much more interested in what the future holds for the business.
  • Financial statements do not include all the strengths and weaknesses of a business, for example the quality and skills of employees. These factors are also likely to affect business performance, especially profitability.
  • Income statements and statement of financial position are not always prepared in the same way by different businesses. Therefore, the ratios do not compare like with like.
  • Businesses are affected by external factors – such as legislation, exchange rates, and economic factors – but it will not be shown in the financial statements.
181
Q

How do owners/shareholders use accounts?

A

They will want to know how well the business is performing and whether they’re getting a good return on their investment.

182
Q

How do potential investors use accounts?

A

They will be interested in the profits of the business and the return that they might expect to get from their investment.

183
Q

How do managers use accounts?

A

They will want to know if financial objectives are being achieved.

184
Q

How do employees use accounts?

A

They will be interested in the profitability of the business which influences their job security. They could also use profit figures to support their claims for higher wages in trade unions.

185
Q

How do trade payables use accounts?

A

The supplier will want to know that the business has sufficient cash to pay its debts when they become due.

186
Q

How do lenders use accounts?

A

They will want to know that they will receive the interest on any money they have loaned the business and that the business will be able to repay its borrowing when it is due.

187
Q

How do governments use accounts?

A

The higher the profits, the higher the tax revenue received by the government.

188
Q

How do customers use accounts?

A

They will want to know that a business will continue to supply them with goods and services which meet their needs and wants.

Business (7 decks)

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