Unit 5 - Finance

Question 1

what is return on investment?

Answer 1

ROI is a measure of a firm’s profitability and performance

Question 2

return on investment (answer %)

Answer 2

operating profit
———————— x100
capital invested

Question 3

profit equation

Answer 3

revenue - total costs = profit

Question 4

what is a variance?

Answer 4

the difference between two numbers

Question 5

what is an adverse variance?

Answer 5

an adverse variance is one that is bad
for the business
- expenditure higher than budget
- income lower than budget
- profit lower than budget

Question 6

what is a favourable variance?

Answer 6

favourable variance is one that is good for the business
- expenditure lower than budget
- income higher than budget
- profit higher than budget

Question 7

limitations of a budget

Answer 7

• are only as good as the data being used
• can lead to inflexibility in decision-making
• need to be changed as circumstances change
• take time to complete and manage
• can result in short term decisions to keep within the budget

Question 8

what is break-even?

Answer 8

break-even is the point at which a business is not making a profit or a loss
- total costs must equal total revenue

Question 9

contribution equation

Answer 9

selling price - variable costs = contribution

Question 10

break even calculation

Answer 10

fixed Costs ÷ (sales price per unit – variable costs per unit) = break even

Question 11

what is the margin of safety?

Answer 11

margin of safety is how much actual output is above the break-even level of output

Question 12

margin of safety equation

Answer 12

actual output level – break-even level of output

Question 13

what is gross profit margin

Answer 13

Gross profit margin (GPM) is a measure of a firm’s profitability by looking at the relationship between gross profit and sales revenue

Question 14

if the gross profit margin is falling what might this mean

Answer 14

• is not managing its cost of sales effectively e.g. are the cost of raw
  materials increasing?
• sales are in decline

Question 15

gross profit margin equation

Answer 15

gross profit
——————- x100
sales revenue

Question 16

what is operating profit margin

Answer 16

operating profit margin (OPM) is a measure of a firm’s profitability by
looking at the relationship between net profit and sales revenue

Question 17

what does it mean if operating profit margin is falling

Answer 17

• is not managing its expenses effectively e.g. wages are increasing or
  overheads are going up
• sales are in decline

Question 18

operating profit margin equation

Answer 18

operating profit
———————— x100
sales revenue

Question 19

what is profit for the year margin

Answer 19

profit for the year margin is a measure of a firm’s profitability by looking at the relationship between profit for the year and sales revenue

Question 20

what does it mean if profit of the year margin is low

Answer 20

• gross profit or operating profit are in decline
• interest rates have changed
• taxation rates have changed

Question 21

profit of the year margin equation

Answer 21

profit for the year
————————— x100
sales revenue

Question 22

sources of finance examples

Answer 22

• debt factoring
• overdrafts
• retained profit
• share capital
• loans
• venture capital
• crowd funding

Question 23

what is debt factoring

Answer 23

the process of selling the debts owed to a business to
a financial institution
- the business will receive funds immediately but at a
reduced rate
- external source of finance

Question 24

advantages of debt factoring

Answer 24

• receives a large amount of
  the debt immediately
• good source of short-term
  finance to address cash flow
  problems
• debts are chased by experts
  saving managers time
• reduces the risk of bad
  debts

Question 25

what is retained profit

Answer 25

profit kept within a business from profit for the year to help finance
future activities
- internal source

Question 26

retained profit advantages

Answer 26

• avoids interest repayments
• does not dilute the business
  ownership

Question 27

retained profit disadvantage

Answer 27

• only an option if sufficient retained
  profit exists within the business
• may cause shareholder dissatisfaction
  if this is at the expense of dividend
  payments
• reduces the security blanket of
  keeping retained profits for
  unforeseen situations or to take
  advantage of new opportunities

Question 28

what is share capital

Answer 28

• finance raised from the sale of shares
• this is a form of equity capital i.e. the shareholder
• becomes a part owner of the business
  shareholders will be rewarded for their investment by the payment of dividends

Question 29

share capital advantages

Answer 29

• only need to pay dividends
  if a profit is being made and
  the amount of dividend is
  not fixed
• possible to raise large
  amounts of finance
• no interest repayments

Question 30

share capital disadvantages

Answer 30

• loss of ownership as
  shareholders are part
  owners
• potential risk of loss of
  control for a Plc with a
  threat of hostile takeovers
• complex and costly process
  of issuing shares, especially
  for a Plc

Question 31

what is venture capital

Answer 31

• investment from an established business into another business
  in return for a percentage equity in the business

Question 32

venture capital advantages

Answer 32

• potential for large sums of money
  for investment
• expertise to help the business
• makes it easier to attract other
  sources of finance
• provides the required capital for
  expansion

Question 33

venture capital disadvantages

Answer 33

• long and complex process
• expert financial projections are
  likely to be required
• initially expensive for the firm
  e.g. legal and accounting fees
• partial loss of ownership
• risk of conflict or perceived
  interference