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AS Level Business Studies > Unit 5 > Flashcards

Unit 5 Flashcards

1
Q

When would a business require finance? (5)

A
  • Setting up a business (start up capital)
  • For working capital
  • For expansion of the business
  • For overtaking other business as a way of expansion
  • For research and development
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2
Q

Def. Start up capital

A

Capital needed by an entrepreneur to set up a business.

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3
Q

Def. Working capital

A

Finance needed to pay for raw materials, day-to-day running costs and credit offered to costumers. Working capital = Current assets - current liabilities.

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4
Q

Def. Capital expenditure

A

Involves the purchase of assets that are expected to last for more than one year, such as buildings or machinery.

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5
Q

Def. Revenue expenditure

A

Involves the spendings on all costs and assets other than fixed assets and includes wages and salaries and materials bought for inventory.

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6
Q

A business without sufficient working capital?

A

Is an illiquid business - unable to pay its immediate or short term debts. The business would have to raise finance quickly (such a bank loans), or it would be forced into liquidation.

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7
Q

Def. liquidity

A

The ability of a firm to be able to pay its short term debts

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8
Q

Def. Liquidation

A

When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors

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9
Q

Disadvantages of too little or too much working capital?

A
  • Too little working capital => unable to pay debts

* Too much working capital => too much opportunity cost, it could have been invested elsewhere such as fixed assets.

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10
Q

What is the working capital cycle?

A

Cash => Inventory => Production => Sell on credit =>

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11
Q

How much working capital?

A

It depends on the length of the working capital cycle. The longer the time period from buying material to receiving payment from customers, the greater the working capital needed.

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12
Q

What are the two types sources of finance?

A
  • Internal sources of finance: possibly from business’s own assets or from profits left in the business
  • External sources of finance: raised from sources outside the business
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13
Q

Types of internal sources of finance (3)

A
  • Retained profits
  • Sale of assets
  • Reductions in working capital
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14
Q

What are retained profits?

A

Any remained net profit after the dividends have been paid is invested back into the business. Once invested into the business, they will not be paid out to shareholders, so they represent a permanent source of finance.

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15
Q

Sale of assets?

A

Assets that are no longer fully employed could be sold to raise cash.

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16
Q

Reductions in working capital?

A

When companies reduce assets, such as inventory levels, by reducing their working capital, capital is released, which can act as a source of finance for other uses.

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17
Q

Benefits of internal sources of finance? (2)

A
  • It doesn’t increase the liabilities or debts of the business
  • No risk of loss of control by the original owners as no shares are sold
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18
Q

Limitations of internal sources of finance? (2)

A
  • Newly formed companies with few ‘spare’ assets cannot benefit from these sources
  • It can slow down business growth, as the pace of development is limited by the annual profits or assets to be sold.
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19
Q

Types of external sources of finance? (3)

A
  • Short term sources
  • Sources of medium term finance
  • Long-term finance
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20
Q

Types of external short term sources of finance? (5)

A
  • Bank overdrafts
  • Trade credit
  • Debt factoring
  • Grants
  • Venture capital
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21
Q

Bank overdrafts

A

• A bank agrees to a business borrowing up to an agreed limit as and when required.
The most ‘flexible’, because the amount raised can vary day to day. For example the business may need to increase the overdraft for short periods of time if customers do not pay as quickly or large delivery of raw materials has to be paid for.

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22
Q

Trade credit

A

Obtaining finance by delaying bills of goods and services received. If suppliers or creditors are providing goods and services without immediate payment, it could be thought of as ‘lending money’.

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23
Q

Debt factoring

A

• selling of claims over debtors to a debt factor in exchange for immediate liquidity (cash) - only a proportion of the value of the debts will be received.

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24
Q

Types of external medium term sources of finance? (2)

A
  • Hire purchase and leasing

* Medium term bank loan (1-5 years)

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25
Q

Hire purchase

A

• An assets is sold to a company that agrees to pay fixed repayments over an agreed period of time (a form of credit). The asset belongs to the company.

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26
Q

Leasing

A

• Obtaining the use of a fixed assets and paying charges over a fixed period of time. This avoids the need for the business to raise large finance to purchase the asset. The risk of using outdated equipment is reduced to the leasing company as they remain the ownership over it.

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27
Q

Types of external long term finance? (3)

A
  • Long term loans from banks
  • Long term bonds or debentures
  • Equity finance
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28
Q

Long term loan from banks

A
  • Loans that do not have to be repaid for at least one year.
  • Can have variable or fixed interest rates
  • Companies borrowing from banks will provide security for the loan - the right to sell an asset is given to the bank if the loan is not repaid => businesses with few assets may find it difficult to obtain loans.
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29
Q

Long term bonds or debentures

A
  • bonds issued by companies to raise debt finance, often with a fixed rate interest
  • a company will sell such bond to an investor
  • the company will agree to pay fixed interest to keep the life of the bond (may be up to 25 years)
  • investors can sell the bond if they can’t wait for their investment to be paid back
  • They are usually not secured
  • When secured on an asset they will be called mortgage debentures
  • Convertible debentures can be converted into shares, so the company will never have to pay it back.
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30
Q

Def. equity finance

A

• Permanent finance raised by companies through the sale of shares.

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31
Q

How can a business go publcic? (2)

A
  • By obtaining a listing on the alternative investment market (AIM), which is a part of the Stock Exchange concerned with smaller companies that want to raise only limited amount of capital. The strict requirements for a full Stock Exchange listing are relaxed.
  • Apply for a full listing on the stock exchange by satisfying the criteria of (a) selling at least £50,000 worth of shares and (b) having a satisfactory trading record.
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32
Q

What are the two main ways of sales of shares?

A
  • Publics issue by prospectus - this advertises the company and its share sale to the public and invites them to apply for the new shares. This is expensive, as the prospectus has to be prepared and issued.
  • Right issue of shares.
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33
Q

Benefits and limitations to rights issue of shares? (2 1)

A

Benefits:
• The ownership of the business does not change
• Raise in capital rather cheaply as no advertising required.
Limitations:
• The increase in the supply of shares would reduce its share price, which would worry current shareholders.

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34
Q

Def. Rights issue

A

Existing shareholders are given the right to buy additional shares at a discounted price.

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35
Q

Grants (3)

A
  • For most european countries, grants come from the government or the European Union.
  • Usually given to small businesses or expanding businesses in developing regions of the country.
  • Grants usually come with conditions attached, such as locations or the number of jobs created. If the conditions are met, grants don’t have to be paid back.
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36
Q

Def. Venture capital

A

Risk capital invested by venture capitalists (who could be specialist organisations or wealthy individuals) in business start-ups or expanding small businesses that have good profit potential but do not find it easy to gain finance from other sources. e.g in ‘high tech’ businesses.

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37
Q

Def. Micro-finance

A

The providence of small capital sums to entrepreneurs by any investors to unincorporated businesses.

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38
Q

Def. Business plan

A

A detailed document giving evidence about a new or existing business, and that aims to convince external lenders and investors to extend finance to the business.

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39
Q

What are the factors influencing finance choices? Name no explanation (6)

A
  • Use to which finance is to be put
  • Cost
  • Amount required
  • Legal structure and desire to retain control
  • Size of existing borrowing
  • Flexibility
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40
Q

Explain how the “use to which finance is to be put” affects the finance choice? (3)

A
  • It is very risky to borrow long term finance for short term needs
  • Permanent capital may be needed for long-term business expansion.
  • Short term finance would be advisable to finance short term needs.
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41
Q

Explain how the “cost” affects the finance choice? (2)

A
  • Even internal finance may have opportunity cost

* Loans may become more expensive during a period of rising interest rates

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42
Q

Explain how the “amount required” affects the finance choice? (2)

A
  • Share issues or debentures could be used to raise large capital sums
  • Bank overdrafts could be used to raise small capital sums
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43
Q

Explain how “legal structure and desire to retain control” affects the finance choice?

A

• If the owners want to retain control of the business, than further sales of shares are unwise. (Rights issue could be used).

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44
Q

Explain how the “size of existing borrowing” affects the finance choice?

A

• The higher the existing debts, the greater the risks of borrowing more. Banks would be more anxious to lend more.

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45
Q

Explain how the “flexibility” affects the finance choice?

A

• When a firm has a variable need for finance, for example it has a seasonal pattern of sales, a short term form of finance would be better.

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46
Q

Uses of cost data? (5)

A
  • Aid ‘profit equations’, to calculate profits and losses
  • Aid profitable decision making
  • Aid other departments e.g marketing departments to make pricing decisions
  • To make comparisons from previous years
  • To forecast
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47
Q

What are the cost classifications? (4)

A
  • Direct cost
  • Indirect cost
  • Fixed cost
  • Variable cost
48
Q

Def. Direct cost

A

• These cost can clearly identify with each unit of production
e.g one direct cost to business studies department is the salary of the business teacher.

49
Q

Def. Indirect cost

A

• Costs that cannot be identified with a unit of production

e.g Indirect cost to a garage is the rent

50
Q

Def. Fixed cost

A

Costs that do not vary with output in the short run. E.g. Rent

51
Q

Def. Variable cost

A

Costs that vary with output. E.g Costs of raw materials.

Not all direct costs are variable costs. For example, if a hotel buys a new juicing machine for the bar department, this is a direct cost to that department - but the cost of the machine will not vary with the number of orange juices being served.

52
Q

Def. Break even point of production

A

The level of output at which total costs equal total revenue - neither a profit nor a loss is made.

53
Q

What are the two ways break even analysis can be undertaken?

A
  • The graphical method

* The equation method

54
Q

What are the three lines of information break even chart shows?

A
  • Fixed costs
  • Total costs
  • Sales revenue

The chart on 25/2/16

55
Q

Def. Margin of safety

A

The amount by which the sales level exceeds the break even level of output.

56
Q

Equation for Total Cost, Total Revenue, Variable Cost, Break Even Quantity?

A

Total Cost = Fixed costs + Variable Costs
Total Revenue= Price x Quantity Sold
Variable Cost = Quantity Sold x Avg Variable Cost
Break Even Quantity = Fixed Cost / (Price - AVC)

57
Q

Break Even analysis reliability?

A
  • Costs and revenues may not always be in a straight line. For example costs can be affected by the output production which may not be smooth.
  • Not all costs can be classified into fixed or variable.
  • It is unlikely that fixed costs will remain the same.
58
Q

What are the internal uses of accounting information? (2)

A
  • Business managers: To measure performance, to help make decisions, to set targets and budgets, to monitor operations of each departments.
  • Workforce: to determine security in their wages and whether it can increase.
59
Q

What are the external uses of accounting information? (5)

A
  • Banks: To decide whether to lend money.
  • Creditors (suppliers): to decide whether the business is liquid enough to pay off debts, to decide whether to press early payments.
  • Customers: To determine whether they will be assured of future supplies of the goods purchased, whether the business is secure
  • Government: to calculate tax, to see if the business is following law, to see if the business creates jobs.
  • Local community: Jobs providence.
60
Q

What are the limitations of public accounts?

A
  • They may not contain: research and development plans, any future plans for expansion, performance of each department, future budgets.
  • They may not be accurate: data may be outdated before published. Even though accounts are check by auditors, there are things that need judgement to decide on their value such as intangible goods. Therefore the business can still be accused of ‘window dressing’ the account.
61
Q

Def. Window dressing

Common ways of window dressing?

A

Window dressing is presenting the company accounts in a favourable light - to flatter the business performance.
Ways to window dress:
• Selling fixed assets at the end of the year to improve liquidity position.
• Reducing the amount of depreciation of fixed assets, to raise profit margins.
• Ignoring bad debts.

62
Q

Management vs. Financial Accounting?

A
  • Financial accounting: Published accounts of the business by legal requirements. e.g preparations of income statements, or statements of financial position.
  • Management Accounting: Information for internal use by the managers who need financial data. e.g Analysis of internal accounts such as budgets.
63
Q

What do income statements show?

A

The gross and net profit of the company. Details how the net profit is split up between dividends to shareholders and retained profits.

64
Q

What are the three sections of an income statement?

A
  • The trading account
  • The Profit and Loss account section
  • The appropriation account

Layout in 1/03/16

65
Q

What is the trading account section?

A

• Shows how the gross profit is made from the trading activities.

66
Q

Def. Gross profit

A

Equal sales revenue - cost of sales

67
Q

Def. Sales revenue

A

The total value of sales made during a trading period.

= selling price x quantity sold

68
Q

Def. Cost of sales

A

Direct cost of purchasing the goods that were sold during the financial year.
=opening inventory + purchases - closing inventory

69
Q

What is the profit and loss account section?

A

Shows the net profit and the profit after tax.

70
Q

Def. Net profit (operating profit)

A

ERROR!

71
Q

Def. Profit after tax

A

ERROR!

72
Q

What is the appropriation account?

A

It is not always published. It shows how the profit after tax is distributed in dividends and retained profit.

73
Q

What are the uses of income statements?

A
  • Used to measure and compare the performance of a business over time or with other firms.
  • Bankers, creditors or investors will need information to decide whether to lend money.
74
Q

Def. Statement of Financial Position

A

An accounting statement that records the value of a business’s assets, liabilities and shareholders’ equity at one point in time.

Layout in pg. 538

75
Q

Def. Shareholder equity

A

ERROR!

76
Q

Def. Share capital

A

Total value of capital raised from shareholders by issuing shares

77
Q

Def. Non current assets

A

fixed assets’. Assets to be kept and used by the business for over a year. e.g machinery

78
Q

Def. Intangible assets

A

Items of value that do not have a physical presence such as patents or trademarks.

79
Q

Def. Inventories

A

Stock

80
Q

Def. Account receivables

A

Debtors. The value of payments to be received from customers who have goods on credit.

81
Q

Def. Current Assets

A

Assets that are likely to be turned into cash before the next balance sheet, less than 1 year. 3 main: Cash, Cash receivables, Inventories.

82
Q

Def. Current liabilities

A

Debts that have to be paid within 1 year.

83
Q

Def. Account payables

A

Creditors. Value of debts for goods bought on credit payable to suppliers.

84
Q

Def. Non current liabilities

A

Value of debts of the business that will be payable after more than 1 year. e.g Loans

85
Q

Def. Goodwill

A

Arises when a business is value at or sold for more than the balance sheet value of its assets possibly due to its reputation.

86
Q

What are the the two main ratio types?

A
  • Profitability ratios

* Liquidity ratios

87
Q

What are the profitability ratios and their meaning?

A

• Gross profit margin: =(Gross profit/ Sales revenue) x 100. Shows how much gross profit a business makes for $1 of sales. Shows managing ability of cost of sales.
• Net profit margin: =(Net profit/Sales revenue) x 100.
how much gross profit a business makes of $1 of sales. Show managing ability of cost of sales and overhead expenses.

88
Q

What are the liquidity ratios and their meaning?

A
  • Current ratio: =Current Assets/ Current liabilities. shows the rate the business affords to pay current liabilities out of their current assets.
  • Acid test ratio: = (Current Assets - Inventories) / Current liabilities.
89
Q

What are the methods to increase profit margins?

A
  • Increase gross and net profits by reducing direct costs of overhead costs. This can be done by using cheaper materials or cutting labour costs.
  • Increase gross and net profits by increasing price.
90
Q

What are the methods to increase liquidity margins?

A
  • Sell off fixed assets for cash then lease these back if needed.
  • Sell of inventories for cash which would improve acid test ratio only
  • Increase loans to inject cash into the business and increase working capital.
91
Q

Def. Cash Flow

A

Record of the cash received by a business over a period of time and the cash outflows from the business.

92
Q

Def. Liquidation

A

When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors

93
Q

Def. Iliquid

A

When a business cannot meet its short term debts

94
Q

Why is cash flow planning vital?

A
  • New business start ups are usually given less credit periods - less time to pay suppliers.
  • It is hard to convince banks or other lenders to lend if they have no trading record. There is also a need to pay back at the right times.
95
Q

Def. Cash inflows

A

Payments in cash received by a business, such as those from customers, debtors or from the bank. e.g receiving a loan.

96
Q

Def. Cash outflows

A

Payments in cash made by a business, such as those to suppliers and workers.

97
Q

Cash vs. Profit

A

Cash is not the same as profit. It is important to always have enough cash in the short term. Profit can wait to be earned in the long term - but cash payments are always being made.

98
Q

Structure of cash flow forecasts

A

pg. 496

or look in the notebook

99
Q

Def. Opening cash balance

A

Cash held by the business at the start of the month.

100
Q

Def. Closing cash balance

A

Cash held at the end of the month becomes next month’s opening balance.

101
Q

What are the causes of cash flow problems? (5)

A
  • Lack of planning
  • Poor credit control
  • Allowing customers too long to pay debts
  • Expanding too rapidly
  • Unexpected events.
102
Q

Cash Flow problems: Lack of planning

A

Cash flow forecasting - planning the future ahead doesn’t prevent any cash flow problems from happening, but it can help prevent the cash flow problems from developing.

103
Q

Cash Flow problems: Poor credit control

A

If the credit control is inefficient, the debtors will not be ‘chased up’ for payment and potential bad debts will not be identified.

104
Q

Def. Credit control

A

Monitoring of debts to ensure that credit periods are not exceed.

105
Q

Def. Bad debt

A

Unpaid costumers’ bills that are now very unlikely to ever be paid.

106
Q

Cash Flow problems: Allowing customers too long to pay debts

A

By allowing customers to pay on credit, it will aid the competition of the business against others. However letting customers too long to pay means reducing short term cash inflows, which would lead to cash flow problems.

107
Q

Cash Flow problems: Expanding too rapidly

A

When the business expands rapidly, it has to pay for expansion and increased wages… => overtrading would lead to cash flow shortages.

108
Q

Def. Overtrading

A

Expanding a business rapidly without obtaining all of the necessary finance so that a cash flow shortage develops.

109
Q

Cash Flow problems: Unexpected events

A

Unforeseen increases in costs - a breakdown of a delivery van that needs to be replaced etc. could lead to negative monthly cash flows.

110
Q

Ways to improve cash flow? (2)

A
  • Increasing cash inflows

* Reducing cash outflows

111
Q

Ways to increase cash inflows? (4)

A
  • Overdraft: Flexible loans businesses can draw up
  • Sale of assets: Cash receipts obtained from selling redundant assets
  • Reduce credits terms to customers: Shorten the period of time
  • Debt factoring: Companies offering immediate cash from the debt
112
Q

Ways to reduce cash outflows? (4)

A
  • Delay payments to suppliers/creditors: Take longer to pay back to decrease short term cash outflows
  • Delay spending on capital equipment
  • Use leasing instead of purchasing equipment
  • Cut overhead spending that does not directly affect output e.g. promotion costs
113
Q

Ways to manage working capital?

A

~~~
4 components need to be managed:
• Debtors
• Creditors
• Inventory
• Cash
```

114
Q

How to manage debtors? (3)

A
  • Not extending credit to customers -extending it for shorter time periods
  • Selling claims on debtors to specialist financial institution acting as debt factoring
  • By discovering whether new customers are creditworthy
115
Q

How to manage creditors?(2)

A
  • Increasing the range of goods and services bought on credit
  • Extend the period of time taken to pay
116
Q

How to manage inventory? (3)

A
  • Keeping smaller inventory levels
  • Using computer systems to record sales and inventory levels to order as required
  • Just in time production method
117
Q

How to manage cash? (3)

A
  • Use cash flow forecasts
  • Wise use of investment of excess cash
  • Arranging overdrafts when there might be too little cash

AS Level Business Studies (5 decks)

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