2.3 Managing Finance

Question 1

What is the formula for profit?

Answer 1

Profit = total revenue - total costs

Question 2

What is the formula for gross profit?

Answer 2

Gross profit = sales revenue - cost of goods sold

Question 3

What is the formula for profit for the year?

Answer 3

Profit for the year = operating profit + other income - other expenditure

Question 4

What is a statement of comprehensive income?

Answer 4

Also called a profit and loss account.
Shows income and expenditure for an accounting period and the resultant profit or loss made.

Question 5

What are three ways of measuring profitability?

Answer 5

Gross profit margin
Operating profit
Profit for the year margin

Question 6

What is the formula for gross profit margin?

Answer 6

(Gross profit / sales revenue) x 100

Question 7

What is the formula for operating profit margin?

Answer 7

(Operating profit / sales revenue) x 100

Question 8

What is the formula for profit for the year margin?

Answer 8

(Profit for the year / sales revenue) x 100

Question 9

What is the difference between cash-flow and profit?

Answer 9

Cash-flow is the difference between inflows of money and outflows.
Profit is the difference between revenue and expenditure.
Cash-flow only includes what has been received whilst profit includes expected receipts.

Question 10

Why might a profitable business have cash-flow problems?

Answer 10

Holding large amounts of inventory
Having sales on long credit periods
Purchase of fixed assets using cash

Question 11

What is liquidity?

Answer 11

How easy it is to convert a business’ assets into cash.

Question 12

What is a statement of financial position?

Answer 12

Also called a balance sheet.
A snapshot of a business’s financial position at a given time.
Shows assets and liabilities.

Question 13

What makes a statement of financial position balanced?

Answer 13

Assets = liabilities + shareholders

Question 14

What are the two key ratios?

Answer 14

Current ratio
Acid test ratio

Question 15

What is the current ratio?

Answer 15

Current ratio = current assets / current liabilities

Question 16

What is the acid test ratio formula?

Answer 16

(Total current assets - inventories) / current liabilities

Question 17

What is an ideal figure for current ratio?

Answer 17

Around 1.5:1 or 2:1
However this must be compared to previous years and other businesses

Question 18

Why should the current ratio stay below 2:1?

Answer 18

Too much money tied up in the business and not being used effectively.

Question 19

What are the implications of a current ratio below 1.5:1?

Answer 19

There might not be enough capital to cover bills.

Question 20

What does current ratio show?

Answer 20

Whether debts can be paid off quickly.

Question 21

How can a business improve its liquidity?

Answer 21

Selling fixed assets.
Raising new finance through share issues or borrowing.
Postponing planned investment.

Question 22

What is working capital?

Answer 22

A measure of an organisation’s short-term financial health.

Question 23

What is the formula for working capital?

Answer 23

Working capital = current assets - current liabilities

Question 24

Why must working capital be managed correctly?

Answer 24

Too little may result in cash-flow problems.
Too much may indicate inefficiences.

Question 25

What are the four stages of the working capital cycle?

Answer 25

Sell to customers on credit
Customers pay up
Buy materials
Produce goods

Question 26

What is business failure?

Answer 26

Where a business ceases operations because of its inability to generate sufficient revenue to cover its expenses.

Question 27

What are some internal causes of business failure?

Answer 27

Poor management
Marketing failure
Poor financial management

Question 28

What are some external causes of business failure?

Answer 28

Competition
Technological change
Economic change
Inability to attain sufficient working capital