Unit C - Business and Finance News Knowledge Flashcards
Outline stock markets.
Companies exist by selling products and/or services. After an initial investment, their sales revenue pays for all the raw materials, staff, offices or factories, ideally leaving enough profits to reward the owners for their initial time, ideas, leadership and upfront cash.
If a company is successful it grows – and then often needs extra money beyond the basic revenues and costs calculation to fund that expansion. This might be to buy more premises or equipment, to invest in research and development of new products and services, or to employ extra staff.
Company directors can raise this money in two different ways. They can do what you might do if you wanted to buy a car or house – arrange an overdraft and/or loan with a bank. This is known as debt financing. Or they can decide to list the company on the stock market, selling ‘stock’ in the business to public and institutional investors. This is known as equity financing.
The stock market, therefore, exists to allow companies to raise money with equity financing by selling shares. A person or organisation who buys a share of a company’s stock becomes a shareholder. This means they (along with other shareholders) are the company’s owners and are entitled to a proportion of its assets – the buildings, offices, factories, raw materials, products and any related trademarks the company owns. Shareholders are also entitled to a share of the company’s profits, distributed via dividend payments. At times when revenues are falling or new investment is needed, profits can be retained by a company to meet debt repayments or in a bid to create higher potential growth.
Companies listed on the stock market are known as PLCs – Public Limited Companies. This means that ordinary shareholders have limited liability: they can lose no more than the cash they have invested. The stock market itself operates as a stock exchange.
The London Stock Exchange (LSE) is one of the oldest and largest stock markets. It serves two customers: companies who want to raise money by offering their stock onto the market through initial public offerings (IPOs) or new issues of shares; and investors eager to own stock in that listed company.
Shares are first issued in the primary market, and are then traded in the secondary market. The vast majority of the LSE’s business takes place in this market of ‘second hand’ stock. Not every company can join the stock market. The LSE has certain criteria that must be met, such as a minimum amount of money to be raised (market capitalisation), a minimum proportion of the company to be in share ownership, and a minimum period that it has been trading as a successful company.
For companies that do not meet these criteria, they can go to the Alternative Investment Market (AIM), which is another stock market that works on the same basic principles but has less strict entry rules.
Using these basic principles, stock markets exist in almost all developed, and in most developing, countries across the world. The largest is in the USA, known as the New York Stock Exchange (NYSE). Other important stock exchanges include the Frankfurt Stock Exchange, the Tokyo Stock Exchange and the Shanghai Stock Exchange.
Stock exchanges are measured by a range of price indices covering different sectors and industries. Each stock market index is calculated from the prices of selected stocks, which therefore measures the value of that section of the stock market. Examples include the Dow Jones Industrial Index and the FTSE-100.
The rise and fall of share prices therefore becomes an important indicator of the strengths and weaknesses of either certain sectors of the economy or, at times, the whole economy. This can be within a single nation, but because large companies are often international and therefore listed on multiple stock exchanges, these rises and falls can quickly cross borders to affect continents and the whole world.
Positive or upward price trends are referred to as bull markets, and this can result in what is called a stock market bubble. Negative or downward price trends are referred to as bear markets, and this can result in what is called a stock market crash. History has seen that bubbles – when shares can be priced above the real worth of stock – often lead to crashes.
Outline commodity markets.
A ‘commodity’ in the global finance world refers to raw materials or other primary products that are bought and sold internationally in bulk.
There are nearly 100 recognised commodity material and products including:
- Seeds, grains and other agricultural products.
- Cattle and other livestock and meat products.
- Oil, coal and other energy products.
- Gold, silver and other precious metals.
- Steel, lead and other industrial metals.
- Diamonds and other minerals and materials.
These materials and products are traded in commodity markets which are officially priced and regulated via commodities exchanges. There are scores of physical and virtual commodities exchanges in countries across the world, and their changing price indices are another indicator of the strengths of various economies and economic sectors. Like the stock market, commodity markets can rise and fall sharply, and these changes quickly cross borders and create problems or benefits for the general public. Examples include the rising costs of fuel on petrol station forecourts (because of oil prices in commodity markets), and the cost of bread in shops (because of wheat prices).
Outline currency markets.
They trade in denominations of money.
Known as the foreign exchange market (often abbreviated to ‘forex’ or ‘FX’), this takes place in financial centres based in all but the least developed countries around the world.
On every weekday, the FX market organises trading between a wide range of different types of buyers and sellers, based on major interbank trading platforms. The rises and falls in the demands of different currencies results in the FX market determining the relative values of different currencies.
This assists international trade and investment activity with fast, regulated currency conversion, a necessity for imports and exports between countries. It also permits speculative trading in the value of currencies based on the different countries’ interest rates
Foreign exchange rates, as we know, affect us all personally at least once a year when we are preparing last minute currency purchases for holidays. But of course they actually affect us all year long, as strong or weak currencies usually reflect the economic health of nations and, in Europe with the euro, a whole continent.
Outline bond markets.
A bond is, in its simplest terms, an official IOU note, more commonly referred to as a debt security. A bond can be issued by a company, a bank or a government, and is effectively a way of arranging a loan with the buyer of that bond. The bond will state when a loan must be repaid and what interest the borrower (the bond issuer) must pay to the bond holder. But because they are official IOUs, these bonds then become an asset which bond holders can buy or sell like anything else. And so banks and investors buy and trade bonds on the bond market.
This bond market is therefore another way that new debt can be created to raise money – the primary market – and where those debts can be bought and sold in the form of bonds – the secondary market. This mechanism provides long-term funding for what are sometimes huge public and private investments in areas like road, rail, construction and other infrastructure projects. Government bonds make up a huge part of bond markets because of their sheer size. In the USA alone, this runs into tens of trillions of dollars. Because they are so integral to government finances, price rises and falls in the bond market have a considerable impact on countries’ interest rates.
Outline hedge funds.
There are all sorts of investors who ‘play’ the above markets – from wealthy individuals with a bit of money at hand, to private investment funds. The latter are called ‘hedge funds’ and use a range of sophisticated strategies to maximise returns. This includes ‘hedging’, which involves making large investments into an asset to reduce the risk of price fluctuations on that asset’s value. For example, airlines can ‘hedge’ against rising oil prices by buying their fuel in advance at a set price. This means that prices rises will not affect them, although they would also not benefit from any reduction in prices. In the wake of the current global financial crisis, governments and central banks are looking in to how to better regulate this risk-taking by hedge funds.
Outline pension funds.
Another important investor group, especially in the stock markets and bond markets, are pension funds. There are thousands of these around the world looking for the safest long- term investments to secure the future pensions of their members. Their funds are huge – often running into hundreds of millions of pounds per fund – and they therefore dominate stock market assets. Pension funds’ decisions on safe investments, and their responses during financial crises, have a large influence on the markets’ rises and falls. The global recession has also affected pension funds and their ability to meet their commitments.
Outline import and export markets.
Imports are the goods and services that a country brings in from foreign countries; exports are the goods and services a country supplies to others. Together, they create international trade. This sounds simple enough, but the relationship between imports and exports is also an important indicator of a country’s economic health.
What is sometimes known as the balance of trade or, to give it its official UK title, the ‘balance of trade’, is the difference between the value of what a country imports and exports. A country has a ‘trade surplus’ if it exports more than it imports; but it has a ‘trade deficit’ if it imports more than it exports. This is sometimes known as a ‘trade gap’. This can get quite complicated, as a country’s balance of trade can be separately measured for products and services, and this can also include financial investments and borrowing, resulting in a balance of payments.
But a healthy country has, overall, more than enough goods and services for its own economy and therefore exports more than it imports. Conversely, a country which needs to import more goods than it can export is not so healthy. This balance can be affected by many factors in different countries, such as labour costs, land costs, raw material costs, tax levels, the availability of finance, the foreign exchange rate and various trade agreement and restrictions, to name just a few.
There are other markets, of course, but in terms of global economics and international finance the above markets – the stock, commodity, currency, bond and import and export markets – are literally the ones which make the world go round. Their rises and falls and changing balances can impact on each other, on different countries and continents, on various economic sectors and on the whole global economy.
Outline the 2007 financial crisis.
Starting in 2007, the world experienced what many politicians and economists called the worst financial crisis since the ‘Great Depression’ of the 1930s. Many observers have pointed to the ‘bubble’ in the US housing market as being one of the main causes of the current crisis. There were many other factors, but one was the easy availability of mortgages to poorer members of the US public – known as the ‘subprime market’. These insecure mortgages were then sold collectively as packages on international markets, where they were traded by banks, and hedge funds, at prices that in retrospect were massively overleveraged – or, in simple language, priced vastly above their real value. When the US house market collapsed, there was a resulting mass failure of subprime mortgages which could no longer be afforded by poor householders. Because these mortgages – millions of them – had been overpriced as collective assets, they were quickly worth next to nothing for the international banks and investors who owned them.
Again, there were many other factors, but this collapse of the subprime market was one of the main reasons that led, at the peak of the crisis, to the threat of collapse for several banks and other financial institutions. Governments had to provide huge subsidies and, in some cases, full or part-nationalisation to help certain banks to survive.
This had a knock-on effect on overall international trade and finance, and at times whole stock exchanges appeared to be on the brink of total collapse due to huge losses and rapidly decreasing prices of stocks and shares. This banking and financial crisis was accompanied by many other factors: rising levels of unemployment; a shortage of oil supply and therefore rising petrol and transport costs; increase in food prices; and a resulting reduction in wider consumer spending.
Outline the Eurozone debt crisis.
One of the obvious results of the global banking crisis was that debt finance became more expensive and less available across the world. This wasn’t helped by the large debts of many European countries, such as Greece and Spain, and their inability to service those debts during the recession. High public sector wages and pension commitments made things worse, as did the Eurozone’s dependence on one currency, the euro, which meant it was harder for member countries to respond individually to the crisis.
Outline the following economic indicators:
- GDP
- GDP per capita
- industrial production
- unemployment
- CPI
- balance of payments
- budget balance
- interest rates
- LIBOR
- Gross domestic product (GDP). Technical definitions of GDP can make it sound more complex than it really is. According to The World Bank, GDP “…is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsides not included in the value of the products”. That’s quite a mouthful. But in everyday language, GDP is simply the market value of everything produced by a nation in a certain period. The words ‘everything produced’ mean all products and services.
- GDP per capita. This is simply a nation’s GDP divided by its population. The measure is useful when comparing one country’s economic health against another. GDP can be expressed as a huge financial figure, but is more often seen as a percentage rise or fall. GDP figures can also be broken down into particular sectors, such as manufacturing, construction and housing.
- Industrial production. In economic terms, industrial production measures the output of a nation’s industrial sector, which includes all manufacturing, mining and utilities. Again, while this can be expressed as a huge financial figure, it has more meaning when seen as a percentage rise or fall from one defined period to the next.
- Unemployment. This measure does what it says on the tin – it records how many people were out of work in a defined period. There are several measures – one based on a survey carried out by the ONS that records ‘unemployment’ and ‘employment’ figures; another is based on the number of people claiming Jobseekers’ Allowance. There is a separate figure recording ‘youth unemployment’, and all these measures are also broken down into UK regions. The ONS produces all these reports under the heading ‘Labour market’. The figures are usually expressed both in total numbers of people involved and in percentage rises and falls from one period to the next.
- Consumer Prices Index (CPI). The CPI is the official measure of inflation of consumer prices in the United Kingdom. This is calculated from the average price increase of 600 different goods and services in 120,000 different retailing outlets. The CPI is now widely used to set any increases in payments of benefits and pensions. This was previously done with what was known as the Retail Price Index (RPI) which includes housing costs (and therefore mortgage costs), which some observers feel was a better way of measuring inflation. That debate continues.
- Balance of payments. This area was touched on when we looked at ‘imports and exports’ in the ‘global economics and international finance section’ of this unit. Basically, it measures whether a nation is a net exporter or importer of products and services, including financial aspects like investment and loans. This is sometimes referred to as the ‘current account balance’, and is referred to as being in ‘deficit’ or ‘surplus’. At its simplest level, to quote economics journalist David Smith in his book Free Lunch: Easily Digestible Economics, the balance of payments is “the sum of all a country’s transactions with the rest of the world”. The resulting current account balance is what Smith describes as “the best overall measure of an economy’s external position and whether it is ‘paying its way’ in the world.”
- Budget balance. The term budget balance is a bit of a misnomer, because it often doesn’t happen. Instead, a budget deficit occurs when government spending is greater than its tax revenues, and it then has to make up the shortfall by borrowing from the private sector. The UK budget deficit is currently measured by public sector net borrowing (PSNB). A budget surplus occurs when tax revenue is greater than government spending. This has only rarely been the case, the last time in the year 2000.
- Interest rates. There are various consumer interest rates: mortgages, savings, overdrafts, loans, etc. But in terms of a nation’s economics – or, more specifically, its monetary policy – the ‘base rate’ of interest is traditionally set either by the government or by the central bank. In the UK, this is the role of the Bank of England, which we will look at next. The base rate set by a government or central bank should not be confused with the interest rate on 10-year government bonds, which is a separate measure and another commonly used economic indicator.
- London Interbank Offered Rate (LIBOR). This is the average interest rate which a number of major banks are prepared to lend money to each other on the London money market, and it is considered to be one of the most crucial rates in the financial world. LIBOR rates are based on a number of maturity periods, from overnight to one year, and in various currencies. The British Bankers’ Association announces the official LIBOR interest rates every weekday.
What are banks?
Put more formally, banks are just like any other business except that their raw material and end product is money. They accept deposits of cash into bank accounts, and for regular and large deposits make a promise to return interest payments for doing so. They then loan that money out to other customers (bank loans, mortgages, etc), or through capital markets, to gain interest payments themselves. The idea is that the interest a bank earns is higher than the interest it pays out, and therefore it makes profits.
What is ‘fractional reserve banking’?
Because of their size and traditional reliability, banks use a system called ‘fractional reserve banking’, which means they only hold a relatively small reserve of the funds deposited, lending the rest out to make profits. This is all highly regulated to different levels within individual countries, and there are also international standards based on the Basel Accords agreement, which applies rules such as ‘minimum capital requirements’.
Outline the UK banking crisis.
This is exactly what went wrong during the banking crisis of 2007, as discussed in the first section of this unit. Basically, the toxic nature of high-risk mortgage debt – known as the ‘sub-prime’ market in the USA – meant banks who had lent huge amounts of money out on capital markets were suddenly unable to recoup the money.
As a result of this, Northern Rock became the first bank in modern times to experience a ‘bank run’ – people demanding their money back all at the same time. This consumer panic occurred when it emerged that Northern Rock had had to approach the Bank of England for a loan facility to continue operating because of defaults on its lending to international capital markets. To prevent Northern Rock’s collapse, the government had to take the bank into public ownership in 2008, effectively writing off a lot of its bad debts and stabilising its operations, before eventually selling it back into the private market to Virgin in 2012.
Northern Rock was not the only bank in trouble as a result of the international credit crunch. In early 2008, the smaller Bradford & Bingley Bank also had to be nationalised to prevent its collapse. And in October 2008, both the Royal Bank of Scotland and HBOS were reported to be within hours of failing as major investors tried to withdraw their funds. This led to Lloyds TSB taking over HBOS, supported by £17 billion of taxpayers’ money from the government, and RBS was only able to continue with a £20 billion injection of government money – both effectively part-nationalisations of these huge banks. This resulted in the infamous resignation of RBS chief executive Sir Freddie Goodwin, provoking widespread anger at the millions he personally received as part of his termination.
The above is only a snapshot of a much wider ensuing banking crisis in the UK, Europe and the world. But the snowball effect meant there had to be changes to the system that regulated banks, and in the UK this included the Bank of England’s new Financial Policy Committee (FPC) and Prudential Regulation Authority (PRA).
Outline the Bank of England.
The Bank of England is what is known as the ‘central bank’ of the UK. Founded in 1694, it was established to act as the government’s official banker – a role it still holds. Most other countries’ central banks are based on the Bank of England model. Whatever the political debates and opinions on recent economic policy, it is widely acknowledged that the Bank of England has a large influence on the UK’s domestic economy. Whether that is a successful influence or not is sometimes debated.
As well as being the main issuer of banknotes, the Bank of England has devolved power from government to set the nation’s ‘monetary policy’. This power came in 1997 when the then Chancellor of the Exchequer, Gordon Brown, gave the Bank of England operational independence – which in summary meant it had control over setting monetary policy to meet an inflation target set by the government. The Bank of England does this via the Monetary Policy Committee.
Outline the MPC.
The Bank of England’s Monetary Policy Committee (MPC) is a group of leading bankers and economists, chaired by the Bank’s governor. It meets for several days a month to analyse, discuss and debate the nation’s various economic indicators and set an interest rate. This is called the Bank of England ‘base rate’, the rate at which it lends money to banks. Banks, building societies and other financial institutions then have to set their own interest rates, commonly referred to as ‘x% above base rate’.
In March 2009, in an attempt to increase the amount of lending and activity in the economy to help the UK weather the recession, the Bank of England set the base rate at 0.5%, the lowest rate in its history. At the time of writing (August 2016), the base rate had just been lowered even further to 0.25%, mainly as a result of the UK’s Brexit referendum. The MPC also authorised a programme of ‘quantitative easing’.
What is quantitative easing?
To put it simply, quantitative easing is when the central bank injects money directly into the economy. This has often happened when interest rates have reached such low levels that economists feel there is no other way to stimulate the economy. This was the position in 2009 when the UK base rate reached an all-time low of 0.5%. There are various ways to apply quantitative easing, but the one chosen by the Bank of England’s MPC was to purchase secure government bonds from the private sector with newly created money.
How will the Bank of England be regulated in the future?
The Financial Policy Committee and Prudential Regulation Authority.
Who is the Chancellor of the Exchequer?
Despite the Bank of England’s increased role in influencing the UK’s economy and finance sector, many of the basic controls are still in the hands of the elected government. The Chancellor of the Exchequer runs these controls on the same basis as any business: revenues and costs. The revenues are created by a multitude of taxes (and borrowing), and the costs are what are spent on things like the NHS, transport infrastructure, social security, defence and all the other government departments, projects, equipment and staff that provide services for the general public.
These incomings and outgoings are continuous, with HMRC assessing, collecting and chasing taxes, and with various government departments making day-to-day decisions on the billions of pounds of expenditure. But all follow the basic principles that are set by the Chancellor in what is currently known as the Autumn Statement and then the more formal Budget. These occasions are when the Chancellor makes what in effect are financial statements and future plans, expressing a general view of the nation’s finances, describing which areas the government intends to spend (or not to spend) on, and announcing the proposed plan of taxation for the next year.
The Chancellor will state what the government intends to spend, in which areas, how this will be paid for, and what the overall affect will be on the country’s debt and deficit levels. These plans not only include investment in certain areas (eg, new schools, new roads, etc) but will also involve cuts to other areas (eg, defence, benefits). Ideally, the Chancellor wants the Budget to balance, but it’s usually more about controlling the resulting deficit, (although there have been occasions of budget surplus).
Who collects the majority of taxes?
HM Revenue and Customs.
Outline the following taxes:
- Income Tax
- Corporation Tax
- Capital Gains Tax
- National Insurance
- Inheritance Tax
- VAT
- Stamp Duty Land Tax (SDLT)
- Insurance Premium Tax
- Air Passenger Duty
- Petroleum Revenue Tax
- Vehicle Excise Duty
- Council Tax
Income Tax. This is a tax that we are all liable to pay on almost all areas of our income. Everyone has a tax allowance, which is income on which no tax is due (this was £10,000 in the 2014/15 tax year for people of working age). Increasing tax rates are then applied to income bands above that allowance. For the 2014/15 tax year: a ‘basic’ rate of 20% on earnings up to £31,865; a ‘higher’ rate of 40% on earning ups from £31,865 to £150,000; and an ‘additional’ rate of 45% on any earnings above £150,000.
These tax allowances and rates are applied to all the money you earn from the following: employment; most pensions; interest on savings; rental income; extra benefits you might get from a job (eg, a company car; and any income from a trust). You don’t pay tax on things like: income from tax-exempt accounts, Individual Savings Accounts (ISAs); Working Tax Credit; Premium Bond wins and other tax- exempt prizes (although you would be taxed on savings income from these prizes).
- Corporation Tax. This is the amount of money that companies pay to the HMRC, based on published rates that are applied to different levels of pre-tax profit. In 2014/15, the rates were 20% for ‘small profits’ of up to £300,000, and a main rate of 21% for profits above that.
- Capital Gains Tax. This is a tax on the gain or profit made when you sell, give away or otherwise dispose of an asset, such as shares or property. Everyone has an allowance of £10,900 on capital gains, with any gain or profit above that amount taxed at either 18% or 28% depending on the total amount of taxable income (2014 figures).
- National Insurance. In effect, this is another tax, although it is specifically used to fund state benefits and pensions, as opposed to going into a general tax pot. It currently (2014) applies to everyone of a working age who earns more than £153 a week, or those who are self-employed making a profit over £5,885 a year. The exact amount you pay depends on how much you earn and whether you’re employed or self-employed.
- Inheritance Tax. This is paid on an estate when somebody dies, and sometimes on trusts or gifts made during someone’s lifetime. Most estates don’t have to pay Inheritance Tax because they’re valued at less than the threshold (currently £325,000). The tax is payable at 40% on the amount over this threshold or 36% if the estate qualifies for a reduced rate as a result of a charitable donation.
There are also a number of ‘indirect taxes’ paid by you or your business on money spent on goods or services. This includes Value Added Tax (VAT). This is a sales tax charged on all a company’s revenues once its turnover exceeds a certain amount per year (in 2016, this was £83,000). VAT-registered companies pass this charge on to purchasing companies and consumers. VAT-registered companies literally collect tax for the government, and this is paid in regular instalments to the HMRC. In return, companies reclaim the VAT on all expenditure on VAT-registered products/services. VAT rates can change, but at the time of writing (August 2016) the rate was 20%. There are some VAT-exempt products (eg, newspapers).
Other indirect taxes include Stamp Duty Land Tax (SDLT) on property transactions, Insurance Premium Tax, Air Passenger Duty, Petroleum Revenue Tax and Vehicle Excise Duty (road tax). Local councils also collect Council Tax to pay for local services such as street lighting and bin collections.
Outline Keynesian and Classical economics.
- Keynesian economics. Based on the ideas of John Maynard Keynes (b.1883, d.1946). It is where a government actively manages demand in the economy with financial policies, tackling recessions with tax cuts and high public expenditure, and the opposite during a boom.
- Classical economics. Based on the ideas of Adam Smith (b.1723, d.1790). Smith talked about ‘the invisible hand of capitalism’, which basically means a laissez- faire attitude by government toward the marketplace. The ‘invisible hand’ guides
everyone’s economic activity, naturally resulting in the greatest good for the greatest number of people, and therefore economic growth.
Why has Britain’s manufacturing industry declined?
From the last quarter of the 20th century, Britain’s involvement in heavy manufacturing fell into heavy decline. Production either switched to cheaper labour found in developing countries, or to increasing technology that steadily replaced the numbers of manual workers needed. This change has been reflected in other Western economies.
Outline the service sector.
At its most basic, people employed in the service sector produce services rather than products. While manufacturers employ people on factory production lines making everything from cars and clothing to chocolate, service sector jobs include everything from housekeepers to tax advisors, from waiters to chefs, and from nursing to teaching. The service sector includes areas such as transport (eg, National Express Group), telecommunications (eg, Vodafone), financial services (eg, HSBC), legal services (eg, Irwin Mitchell), healthcare (eg, BMI Healthcare), shopping (eg, Tesco) and leisure and entertainment services (eg, Gala Coral). The list could go on – but think hotels, bars, nightclubs, and you’re talking about the service sector.
Outline privatisation.
Another change in the modern economy was mass privatisation of public organisations. What used to be nationalised sectors, such as telephones, railways, water, gas and electricity, became private companies in the latter part of the 20th century. According to some observers, this change was beneficial in that it raised much needed finance for the British government and for new investment into research, technology and new, greener energy resources. Others decry the loss of national control over such crucial sectors, and claim that too many ‘fat cat’ bosses have benefitted from profits and dividends that should have been shared by the public, or reinvested for the public. British Telecom, British Gas and Royal Mail and three good examples of former public utilities that are now private companies trading on the stock market.
Outline entrepreneurs and the small and medium enterprise (SME) sector.
We have looked at the make-up of large, national and multi-national companies in the section above, under ‘stock markets’. Basically, while some firms remain ‘independently owned’ as large family or private businesses, once they are above a certain size many become listed on a stock market as a PLC in order to raise funds for further expansion. But what about smaller firms – how do they start and what legal structure do they take?
Most businesses are founded by entrepreneurs who often begin by themselves with an idea of a product or service. For example, if you spotted the opportunity for a window cleaner in your suburb, you could launch a business by yourself, earning revenues and paying yourself profits after costs, which would then be taxed. You could be known as a ‘sole trader’ and would quite easily exist without any other structure – sole traders being recognised by and accountable to HM Revenues and Customs. If you wanted to expand you could form a partnership with another person, where you share the work, profit and taxes.
As things get bigger, you might find yourself taking on more work, responsibilities, staff and debt, and so might at some stage decide to limit your liability by forming a limited company. This would mean that should your company fail, you would only be liable for what you have invested in or guaranteed to the company, whereas sole traders and partnerships have unlimited liability.
Whichever structure you adopt, by trading you have become an SME – a small and medium enterprise. Within this sector, you are considered a ‘micro’ company if you have between one and ten employees; a ‘small’ company with between 11 and 50 employees; and a ‘medium-sized’ enterprise if you have between 51 and 250 employees.
Outline what a profit and loss account is and how to read it. Mention:
- turnover
- cost of sales
- gross profit
- administrative expenses
- operating profit
- interest
- pre-tax profit
- tax
- profit for the financial year
A ‘profit and loss account’ shows how a company’s revenues during a certain time period have been transformed into net income.
- Turnover. This is the amount of cash a business has earned by selling its products or services. It is related to base sales – and does not include Value Added Tax (VAT).
- Cost of sales. This relates to items like salaries, social security payments, sub-contractors’ fees and raw materials. In most cases, these are deemed to be ‘direct costs’, directly related to manufacture or providing a service.
- Gross profit. This is a sum of the above; turnover, minus cost of sales = gross profit.
- Administrative expenses. This relates to items like office stationary, phone bills, mileage, hotels, parking, subsistence, and so on. In most cases, these are deemed to be ‘indirect costs’ to a business.
- Operating profit. This is a sum of the above; gross profit, minus administrative expenses = operating profit.
- Interest. This relates to any interest payable on cash in bank accounts.
- Pre-tax profit (or profit on ordinary activities before taxation). This is a sum of the above; operating profit, plus interest = pre-tax profit.
- Tax (or tax of profit on ordinary activities). This is the amount of Corporation Tax taken by HM Revenues and Customs.
- Profit for the financial year (or post-tax profit). This is a sum of the above; pre-tax profit, minus tax = profit (post-tax).
Outline what a balance sheet is and how to read it. Mention:
- fixed assets/tangible assets
- current assets
- creditors
- net current assets
- total assets less current liabilities
- provisions for liabilities
- net assets
- reserves
A ‘balance sheet’ shows a company’s assets, liabilities and shareholders’ equity at a specific point in time:
- Fixed assets (or tangible assets). This relates to property or assets that a company owns and uses in the production of its income. Items like computers, buildings and machines.
- Current assets. This relates to stock, debtors (firms or people who owe the company money for products/services) and cash at bank (the balance in the company’s bank account).
- Creditors. This relates to amounts that the company owes or is about to owe to other companies/people for products and services, (usually calculated as anything not yet paid, but due to be paid within one year).
- Net current assets. This is a sum of the current assets, minus creditors = net current assets.
- Total assets less current liabilities. This sounds complicated, but is basically an accounting term that allows a company to add its fixed assets onto its net current assets.
- Provisions for liabilities. This relates to bills or costs that it is estimated will occur, but have not yet been received as invoices or payments.
- Net assets. This is a sum of the above; total assets less current liabilities, minus provisions for liabilities = net assets.
- Reserves. This is the amount of cash that a company is calculated to have (or not to have) after all the above considerations.
Outline ‘notes to the financial statements’ and what they may include.
‘Notes to the financial statements’ are listed to cover other financial transactions, or to explain the detail of entries in the profit and loss account and the balance sheet. These can include:
- Dividends. When there are ‘profits for the financial year’ (‘post-tax profits’), these can be paid out to shareholders in dividends, apportioned according to their shareholdings. Sometimes, with shareholders’ agreement, no dividends are paid out to fund investment or to boost reserves in the face of falling revenues.
- Directors’ loan accounts. This is mainly used in limited companies to enable owners to borrow money from or loan money to the company.
AAA-rating
The best credit rating that can be given to a borrower’s debts, indicating that the risk of a borrower defaulting is minuscule.
ACAS
Advisory, Conciliation and Arbitration Service. ACAS is a non-departmental government organisation ‘devoted to preventing and resolving employment disputes’. It offers advice, training and mediation services.
Administration
A rescue mechanism for UK companies in severe trouble. It allows them to continue as a going concern, under supervision, giving them the opportunity to try to work their way out of difficulty. A firm in administration cannot be wound up without permission from a court.
AGM
An annual general meeting, which companies hold each year for shareholders to vote on important issues such as dividend payments and appointments to the company’s board of directors. If an emergency decision is needed - for example in the case of a takeover - a company may also call an exceptional general meeting of shareholders or EGM.
AIM
AIM (formerly the Alternative Investment Market) is a sub-market of the London Stock Exchange that was launched on 19 June 1995 as a replacement to the previous Unlisted Securities Market (USM) that had been in operation since 1980. It allows companies that are smaller, less-developed, or want/need a more flexible approach to governance to float shares with a more flexible regulatory system than is applicable on the main market.
APEC
The Asia-Pacific Economic Cooperation is an inter-governmental forum for 21 member economies in the Pacific Rim that promotes free trade throughout the Asia-Pacific region. Its aim is ‘to establish new markets for agricultural products and raw materials beyond Europe’ and is headquartered in Singapore.
Arab League
A regional organization of Arab countries in and around North Africa, the Horn of Africa and Arabia, Algeria, Bahrain, Comoros, Djibouti, Egypt, Iraq, Jordan, Kuwait, Lebanon, Libya, Mauritania, Morocco, Oman, Palestine, Qatar, Saudi Arabia, Somalia, Sudan, Syria, Tunisia, United Arab Emirates, Yemen, to draw closer the relations between member States and co-ordinate collaboration between them, to safeguard their independence and sovereignty, and to consider in a general way the affairs and interests of the Arab countries.
ASEAN
The Association of Southeast Asian Nations is a regional intergovernmental organization comprising ten countries in Southeast Asia, which promotes intergovernmental cooperation and facilitates economic, political, security, military, educational and sociocultural integration among its members and other countries in Asia. Its member states are Indonesia, Thailand, Malaysia, Singapore, Philippines, Vietnam, Brunei, Cambodia, Myanmar, and Laos.
Assets
Things that provide income or some other value to their owner.
Fixed assets (also known as long-term assets) are things that have a useful life of more than one year, for example buildings and machinery; there are also intangible fixed assets, like the good reputation of a company or brand.
Current assets are the things that can easily be turned into cash and are expected to be sold or used up in the near future.
AU
African Union. Organisation consisting of the 55 member states of Africa. Claims to ‘promote Africa’s growth and economic development by championing citizen inclusion and increased cooperation and integration of African states.’
Austerity
Economic policy aimed at reducing a government’s deficit (or borrowing). Austerity can be achieved through increases in government revenues - primarily via tax rises - and/or a reduction in government spending or future spending commitments.
Bailout
The financial rescue of a struggling borrower. A bailout can be achieved in various ways:
- providing loans to a borrower that markets will no longer lend to
- guaranteeing a borrower’s debts
- guaranteeing the value of a borrower’s risky assets
- providing help to absorb potential losses, such as in a bank recapitalisation
Bankruptcy
A legal process in which the assets of a borrower who cannot repay its debts - which can be an individual, a company or a bank - are valued, and possibly sold off (liquidated), in order to repay debts.
Where the borrower’s assets are insufficient to repay its debts, the debts have to be written off. This means the lenders must accept that some of their loans will never be repaid, and the borrower is freed of its debts. Bankruptcy varies greatly from one country to another, some countries have laws that are very friendly to borrowers, while others are much more friendly to lenders.
Base rate
The key interest rate set by the Bank of England. It is the overnight interest rate that it charges to banks for lending to them. The base rate - and expectations about how the base rate will change in the future - directly affect the interest rates at which banks are willing to lend money in sterling.
Basel Accords
The Basel Accords refer to a set of agreements by the Basel Committee on Bank Supervision (BCBS), which provide recommendations on banking regulations. The purpose of the accords is to ensure that financial institutions have enough capital to meet obligations and absorb unexpected losses.
Basis point
One hundred basis points make up a percentage point, so an interest rate cut of 25 basis points might take the rate, for example, from 3% to 2.75%.
B2B
Business-to-business. Where a business trades directly with another. E.g. a car maker buying parts from an engineering company.
BASIC countries
Four large newly industrialized countries, Brazil, South Africa, India, China, to act jointly on climate change and emissions reduction.
BBA
The British Bankers’ Association is an organisation representing the major banks in the UK - including foreign banks with a major presence in London. It is responsible for the daily Libor interest rate which determines the rate at which banks lend to each other.
BCC
British Chambers of Commerce. The BCC represents the interests of more than 100,000 businesses through 52 regional Chambers of Commerce across the UK. It states that ‘our mission is to make the Chamber network an essential part of growing business; we do this by sharing opportunities, knowledge and expertise’.
Bear market
In a bear market, prices are falling and investors, fearing losses, tend to sell. This can create a self-sustaining downward spiral.
BEIS
The Department for Business, Energy and Industrial Strategy. Formed by the merger of the Department for Business, Innovation and Skills (BIS) and the Department of Energy and Climate Change (DECC) in July 2016.
Big Four (Western Europe)
This refers to France, Germany, Italy and the United Kingdom. These countries are considered major European powers and they are the Western European countries individually represented as full members of the G7, the G8, the G-10 and the G20. This also has an impact on the Eurovision Song Contest, when these countries added to Spain, are turned the BIG 5.
Bill
A debt security- or more simply an IOU. It is very similar to a bond, but has a maturity of less than one year when first issued.
BIMSTEC
A group of countries in South Asia and South East Asia around the Bay of Bengal to promote technological and economic co-operation, which includes Bangladesh, Bhutan, India, Myanmar, Nepal, Sri Lanka, and Thailand.
BIS
The Bank for International Settlements is an international association of central banks based in Basel, Switzerland. Crucially, it agrees international standards for the capital adequacy of banks - that is, the minimum buffer banks must have to withstand any losses. In response to the financial crisis, the BIS has agreed a much stricter set of rules. As these are the third such set of regulations, they are known as ‘Basel III’.
Black (or underground) economy
Often known as ‘cash-only’ business, this is illegal, unofficial and kept hidden from the tax office. Eg, if you pay a builder in cash, or neglect to tell the tax office that you were paid for a service provided, you are participating in the black or underground economy.
Bond
A debt security, or more simply, an IOU. The bond states when a loan must be repaid and what interest the borrower (issuer) must pay to the holder. They can be issued by companies, banks or governments to raise money. Banks and investors buy and trade bonds.
BRICS
BRICS is the acronym coined to associate five major emerging national economies: Brazil, Russia, India, China, and South Africa. The BRICS members are known for their significant influence on regional affairs.
Bull market
A bull market is one in which prices are generally rising and investor confidence is high.
CANZUK
The current personal union and proposed international organisation composed of Canada, Australia, New Zealand, and the United Kingdom.
Capital
For investors, it refers to their stock of wealth, which can be put to work in order to earn income. For companies, it typically refers to sources of financing such as newly issued shares.
For banks, it refers to their ability to absorb losses in their accounts. Banks normally obtain capital either by issuing new shares, or by keeping hold of profits instead of paying them out as dividends. If a bank writes off a loss on one of its assets - for example, if it makes a loan that is not repaid - then the bank must also write off a corresponding amount of its capital. If a bank runs out of capital, then it is insolvent, meaning it does not have enough assets to repay its debts.
Capital adequacy ratio
A measure of a bank’s ability to absorb losses. It is defined as the value of its capital divided by the value of risk-weighted assets (ie taking into account how risky they are). A low capital adequacy ratio suggests that a bank has a limited ability to absorb losses, given the amount and the riskiness of the loans it has made.
A banking regulator - typically the central bank - sets a minimum capital adequacy ratio for the banks in each country, and an international minimum standard is set by the BIS. A bank that fails to meet this minimum standard must be recapitalised, for example by issuing new shares.
Capex
Capital expenditure. The amount of money a company spends on buying fixed assets. E.g., computers, land or machinery. Because this usually lasts for more than one year, capex does not appear in annual profit and loss figures. Instead, the amount is ‘capitalised’ in company accounts, then depreciated over a number of years.
Capitulation (market)
The point when a flurry of panic selling induces a final collapse – and ultimately a bottoming out - of prices.
Carry trade
Typically, the borrowing of currency with a low interest rate, converting it into currency with a high interest rate and then lending it. The most common carry trade currency used to be the yen, with traders seeking to benefit from Japan’s low interest rates. Now the dollar, euro and pound can also serve the same purpose. The element of risk is in the fluctuations in the currency market.
Chapter 11
The term for bankruptcy protection in the US. It postpones a company’s obligations to its creditors, giving it time to reorganise its debts or sell parts of the business, for example.
CBI
Confederation of British industry. The CBI states it is “the UK’s premier business lobbying organisation, providing a voice for employers at a national and international level”. It claims to “speak for more than 240,000 companies of every size, including many in the FTSE 100 and FTSE 350, mid-caps, SMEs, micro businesses, private and family owned businesses, start ups, and trade associations”.
CIS
Commonwealth of Independent States, a political alliance between the former Soviet Republics of Russia, Armenia, Azerbaijan, Belarus, Moldova, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, Uzbekistan. The CIS encourages cooperation in economic, political and military affairs and has certain powers relating to the coordination of trade, finance, lawmaking, and security. It has also promoted cooperation on cross-border crime prevention.
CIVETS
Six emerging markets countries, Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa, a diverse and dynamic economy and a young, growing population.
CMA
Competition and Markets Authority. The CMA began operating in April 2014, taking over the roles of the former Competition Commission and the Office of Fair Trading. It’s a non-ministerial government department in the UK, responsible for strengthening business competition and preventing and reducing anti-competitive activities.
CDO
Collateralised debt obligations. A financial structure that groups individual loans, bonds or other assets in a portfolio, which can then be traded. In theory, CDOs attract a stronger credit rating than individual assets due to the risk being more diversified. But as the performance of many assets fell during the financial crisis, the value of many CDOs was also reduced.
Commercial paper
Unsecured, short-term loans taken out by companies. The funds are typically used for working capital, rather than fixed assets such as a new building. The loans take the form of IOUs that can be bought and traded by banks and investors, similar to bonds.
Commodities
Commodities are products that, in their basic form, are all the same so it makes little difference from whom you buy them. That means that they can have a common market price. You would be unlikely to pay more for iron ore just because it came from a particular mine, for example.
Contracts to buy and sell commodities usually specify minimum common standards, such as the form and purity of the product, and where and when it must be delivered.
The commodities markets range from soft commodities such as sugar, cotton and pork bellies to industrial metals such as iron and zinc.
Companies House
This is the UK’s Registrar of Companies and is a formal agency of the government. Its main functions are to incorporate and dissolve limited companies; to examine and store company information delivered under the Companies Act and related legislation; and to make this information available to the public.
Core inflation
A measure of CPI inflation that strips out more volatile items (typically food and energy prices). The core inflation rate is watched closely by central bankers, as it tends to give a clearer indication of long-term inflation trends.
Correction (market)
A short-term drop in stock market prices. The term comes from the notion that, when this happens, overpriced or underpriced stocks are returning to their “correct” values.
CoE
The Council of Europe (CoE) is an international organisation founded in the wake of World War II to uphold human rights, democracy and the rule of law in Europe. Founded in 1949, it has 47 member states and is separate to the EU.
CPI
The Consumer Prices Index is a measure of the price of a bundle of goods and services from across the economy. It is the most common measure used to identify inflation in a country. CPI is used as the target measure of inflation by the Bank of England and the ECB.
Credit crunch
A situation where banks and other lenders all cut back their lending at the same time, because of widespread fears about the ability of borrowers to repay.
If heavily-indebted borrowers are cut off from new lending, they may find it impossible to repay existing debts. Reduced lending also slows down economic growth, which also makes it harder for all businesses to repay their debts.
CDS
Credit default swap. A financial contract that provides insurance-like protection against the risk of a third-party borrower defaulting on its debts. For example, a bank that has made a loan to Greece may choose to hedge the loan by buying CDS protection on Greece. The bank makes periodic payments to the CDS seller. If Greece defaults on its debts, the CDS seller must buy the loans from the bank at their full face value. CDSs are not just used for hedging - they are used by investors to speculate on whether a borrower such as Greece will default.
Credit rating
The assessment given to debts and borrowers by a ratings agency according to their safety from an investment standpoint - based on their creditworthiness, or the ability of the company or government that is borrowing to repay. Ratings range from AAA, the safest, down to D, a company that has already defaulted. Ratings of BBB- or higher are considered “investment grade”. Below that level, they are considered “speculative grade” or more colloquially as junk.
Currency peg
A commitment by a government to maintain its currency at a fixed value in relation to another currency. Sometimes pegs are used to keep a currency strong, in order to help reduce inflation. In this case, a central bank may have to sell its reserves of foreign currency and buy up domestic currency in order to defend the peg. If the central bank runs out of foreign currency reserves, then the peg will collapse.
Pegs can also be used to help keep a currency weak in order to gain a competitive advantage in trade and boost exports. China has been accused of doing this. The People’s Bank of China has accumulated trillions of dollars in US government bonds, because of its policy of selling yuan and buying dollars - a policy that has the effect of keeping the yuan weak.
Dead cat bounce
A phrase long used on trading floors to describe the small rebound in market prices typically seen following a sharp fall.
Debt restructing
A situation in which a borrower renegotiates the terms of its debts, usually in order to reduce short-term debt repayments and to increase the amount of time it has to repay them. If lenders do not agree to the change in repayment terms, or if the restructuring results in an obvious loss to lenders, then it is generally considered a default by the borrower. However, restructuring can also occur through a debt swap - a voluntary agreement by lenders to switch existing debts for new debts with easier repayment terms - in which case it can be very hard to determine whether the restructuring counts as a default.
Default
Strictly speaking, a default occurs when a borrower has broken the terms of a loan or other debt, for example if a borrower misses a payment. The term is also loosely used to mean any situation that makes clear that a borrower can no longer repay its debts in full, such as bankruptcy or a debt restructuring.
A default can have a number of important implications. If a borrower is in default on any one debt, then all of its lenders may be able to demand that the borrower immediately repay them. Lenders may also be required to write off their losses on the loans they have made.
DAC
The Organisation for Economic Co-operation and Development’s (OECD) Development Assistance Committee (DAC) is a forum to discuss issues surrounding aid, development and poverty reduction in developing countries. It describes itself as being the “venue and voice” of the world’s major donor countries.
Deficit
The amount by which spending exceeds income over the course of a year.
In the case of trade, it refers to exports minus imports. In the case of the government budget, it equals the amount the government needs to borrow during the year to fund its spending. The government’s “primary” deficit means the amount it needs to borrow to cover general government expenditure, excluding interest payments on debts. The primary deficit therefore indicates whether a government will run out of cash if it is no longer able to borrow and decides to stop repaying its debts.
