Unit 5

Question 1

The value of setting financial objectives

Answer 1

-they may act as a measure of performance
-they provide targets which can be a focus for decision making
-potential investors or creditors may be able to assess the viability of the business

Question 2

Cash flow

Answer 2

the difference between the actual amount of money a business receives and the actual amount it pays out (outflows)

Question 3

Profit

Answer 3

the difference between all sales revenue (even if payment has not yet been received) and expenditure

Question 4

Gross profit

Answer 4

gross profit = sales revenue - direct cost of production

Question 5

Operating profit

Answer 5

operating profit = gross profit - expenses

Question 6

Profit for the year

Answer 6

profit for the year = operating profit - other expenditure

Question 7

Cash flow objectives

Answer 7

-targets for monthly closing balances
-reduction of bank borrowings to a target level
-reduction of seasonality in sales
-targets for achieving payment from customers
-extension of the business’s credit period to pay suppliers

Question 8

Capital expenditure

Answer 8

The money spent on fixed assets such as buildings and equipment and represents long term investment into the business

Question 9

Return on investment

Answer 9

return on investment = profit from investment / capital invested x 100

Question 10

Capital structure of the business

Answer 10

The long term capital (finance) of a business

Question 11

Total capital formula

Answer 11

Total capital = loan capital + equity

Question 12

External influences on financial objectives and decisions

Answer 12

-competitor actions
-market forces
-economic factors
-political factors
-technology

Question 13

Internal influences on financial objectives and decisions

Answer 13

-corporate objectives
-resources available
-operational factors

Question 14

Budget

Answer 14

A financial plan

Question 15

Income budget

Answer 15

Forecasted earnings from sales, sometimes called a sales budget

Question 16

Expenditure budget

Answer 16

Sets out the expected spending of a business, broken down into a number of categories.

Question 17

Why do businesses set budgets?

Answer 17

-they are an essential element of a business plan, a bank is unlikely to grant a loan without evidence of this in a particular form of financial planning
-help businesses decide whether or not to go ahead with a business idea
-can help with pricing decisions

Question 18

Difficulties of setting budgets

Answer 18

-there may be no historical evidence available to a business
-forecasting costs can be problematic
-competitors may respond to the actions of a business by cutting prices or promoting their products heavily

Question 19

Variance analysis

Answer 19

The study by managers of the differences between planned activities in the form of budgets and the actual results that were achieved

Question 20

Positive variance

Answer 20

Costs are lower than forecast or profit or revenues higher

Question 21

Negative variance

Answer 21

Costs are higher than expected or revenues are lower than anticipated

Question 22

Responses to positive variance

Answer 22

-to increase production
-to reduce prices if costs are below expectations to increase sales
-to reinvest into the business or pat shareholders higher dividends

Question 23

Negative variance responses

Answer 23

-reduce costs
-increase advertising
-reduce prices to increase sales

Question 24

Benefits of budgeting

Answer 24

-targets can be set for each part of the business
-inefficiency waste can be identified
-can make managers think about financial implications

Question 25

Drawbacks of budgeting

Answer 25

-the operation of budgets can become inflexible -budgets have to be accurate to have any meaning

Question 26

Structure of cash flow forecast

Answer 26

-receipts- in which the expected total month by month receipts are recorded -payments- in which the expected monthly expenditure item is recorded -running balance in which a running total of the expected bank balance at the beginning and end of each month is recorded

Question 27

Contribution formulas

Answer 27

Contribution = sales revenue - variable costs Contribution = sales price per unit - variable cost per unit

Question 28

Total contribution formula

Answer 28

Total contribution = unit contribution x output

Question 29

Break even formula

Answer 29

Break even = fixed costs / contribution per unit

Question 30

Profit formula using contribution

Answer 30

Profit = total contribution - fixed costs

Question 31

Benefits of break even analysis

Answer 31

-starting a new business -supporting loan applications -measuring profit and losses

Question 32

Drawbacks of break even analysis

Answer 32

-no costs are truly fixed -total cost line should not be represented by a straight line because this takes no account of the discounts available for bulk buying -sales revenue assumes that all output produced is sold and at a uniform price which is unrealistic

Question 33

Profit margins

Answer 33

Type of profit / sales revenue x 100 Profits- gross profit, operating profit, profit for the year

Question 34

Payables

Answer 34

The money owed for goods and services that have been purchased on credit

Question 35

Receivables

Answer 35

Money owed by a business’ customers for goods and services purchased on credit

Question 36

The two main sources of external finance

Answer 36

Equity- money provided by shareholders or owners. It does not need to be paid pack so their is no interest on it. Shareholders can sell their shares if they want their money back. Dividends will need to be paid to shareholders Loans- money raised from a creditor but have to be paid back including interest

Question 37

Other sources of external finance

Answer 37

Venture capital- mostly with small or medium sized businesses that may struggle to raise money from traditional sources may have a venture capitalist that provides funds a loan or in return for a share of the business Mortgages- loan granted for buying land or buildings Crowdfunding- a large number of people contribute a small amount of money

Question 38

Sources of internal finance

Answer 38

Retained profit- profit that is not paid to shareholders and is kept within the business for future investment Sale of assets- a business sells assets it no longer requires such as machinery, a warehouse and factory space or land. Although this can raise large amounts the business needs to be sure they won’t be needed in the future

Question 39

Short term sources of finance

Answer 39

Overdraft- a bank allows a business to overspend on its bank account up to an agreed limit Debt factoring- a business sells its bills (invoices) that have not been paid to a third party factoring company for a discounted amount to receive an immediate cash advance Trade credit- a business receives materials but pays for them at a later date. Trade credit periods can vary from a week to several months

Question 40

Retained profit advantages and disadvantages

Answer 40

Advantages -no interest to pay -does not have to be paid back -no dilution of shares Disadvantages -shareholders may have reduced dividends

Question 41

Sales of assets advantages and disadvantages

Answer 41

Advantages -no interest to pay -does not have to be paid back -no dilution of shares Disadvantages -once sold the assets are gone forever

Question 42

Equity advantages and disadvantages

Answer 42

Advantages -no interest to pay -does not have to be paid back Disadvantages -might upset existing shareholders

Question 43

Loans advantages and disadvantages

Answer 43

Advantages -no dilution of shares Disadvantages -interest payments -set maturity date

Question 44

Overdraft advantages and disadvantages

Answer 44

Advantages -quick and easy to follow -interest paid only on an amount overdrawn Disadvantages -interest payments higher than for a loan

Question 45

Debt factoring advantages and disadvantages

Answer 45

Advantages -immediate cash -improves cash flow -protection from bad debts -reduced administration costs Disadvantages -expensive -customer relations may be affected

Question 46

Trade credit advantages and disadvantages

Answer 46

Advantages -eases cash flow Disadvantages -if late paying, can damage credit history

Question 47

Reasons opportunity cash flow problems

Answer 47

Poor management- if managers don’t forecast and manage cash flow problems may arise Giving too much trade credit- giving customers lots of time to settle accounts, slows business’ cash inflows reducing its cash balance Overtrading- a business expands rapidly without planning how to finance expansion Unexpected expenditure- a business may incur unexpected costs such as break down of a machine leading to significant outflows of cash

Question 48

Methods of improving cash flow

Answer 48

Factoring- a business sells its outstanding debtors to a specialist debt collector. Sales and leaseback- the owner of an asset sales it and leases it back Improves working capital control- selling stocks of finished good quickly and making customers pay on time or offering less trade credit Persuading suppliers to offer longer periods of trade credit

Question 49

Methods of increasing profits

Answer 49

-increasing prices -cutting costs -using capacity as fully as possible -increasing efficiency

Question 50

Problems improving cash flow

Answer 50

Factoring- profit margin is reduced to the cost of factoring Sales and leaseback- asset is removed forever and rent has to be paid Working capital control- customers may be put off by reduced credit periods

Question 51

Difficulties of improving profit

Answer 51

Increasing prices- may reduce sales and revenue Cutting costs- likely to result in a reduction in quality Use capacity fully- may cause problems in matching supply with demand Increasing efficiency- may result in redundancies if technology is introduced