2.3 - managing finance Flashcards
(27 cards)
Why do businesses measure their profits on a regular basis?
Businesses measure their profits on a regular basis so they can compare their profits from the current period to the profits from previous periods, to measure their progress.
What is the formula for percentage change in profit?
Percentage change in profit = current years profit - previous years profit / previous years profit x 100
What are the different types of profit and what are they?
- Gross profit - the amount left over when the cost of sales is subtracted from total revenue
- Operating profit - this considers both the cost of sales and operating expenses
- Net profit - cosniders the cost of any interest the business has to pay for borrowing money
What are the formulas for gross, operating, and net profit?
Gross profit = total revenue - cost of sales
Operating profit = gross profit - other operating expenses
Net profit = operating profit - interest
What is a profit and loss account (statement of comprehensive income)?
A profit and loss account shows how much money have been coming into the business (revenue) and how much has been going out (expenses) over a period of time.
These figures can be used in assessing a business’s financial performance
What are profit margins?
Profit margins measure the relationship between the profit made and the revenue. They tell you what percentage of the selling price of a product is actually profit.
They show how profitable a business is
What are the different types of profit margins?
- Gross profit margin - measures gross profit as a percentage of revenue
- Operating profit margin - takes into account all the costs of regular trading
- Net profit margin - measures the profit for the year as a percentage of revenue
What are the formulas for the different profit margins?
- Gross profit margin = Gross profit / revenue x 100
- Operating profit margin = operating profit / revenue x 100
- Net profit margin = Net profit / revenue x 100
What are some of the methods businesses use to increase profit margins?
- Increasing prices
- Reducing their price to increase demand
- Improve product quality
- Reduce operating expenses
What is the difference between profit and cash?
Profit is the money that a business has left from its revenue once costs have been paid.
Cash is what a business has now to pay its bills.
What are balance sheets (statements of financial position)?
Balance sheets are a snapshot of a firms finances at a fixed point in time.
They show the value of all the business’s assets, and all its liabilities.
They also show the value of all the capital (money invested in the business) and the source of capital.
What are the 2 things assets can be?
Assets can be non-current or current.
Non current assets are assets that the business is likely to keep for more than a year.
Current assets are assets that the business is likely to exchange for cash within the accounting year.
What are liabilities?
Liabilities are debts the business owes.
Current liabilities are debts which need to be paid off within a yaer.
Non current liabilities are debts that the business will pay off over several years.
What does liquidity mean?
The liquidity of an asset is how easily it can be turned into cash and used to buy things.
Cas is very liquid, non current assets such as factories are not liquid.
What is a liquidity ratio?
a liquidity ratio shows how liquid a firm is.
There are two liquidity ratios:
- Current ratio
- Acid test ratio
What is solvency?
Solvency refers to the business’s ability to meet its long term financial liabilities, by having enough assets to cover non current liabllities
What is the current ratio?
The current ratio compares current assets to current liabilitites so a business can assess whether they have enough current assets to pay off current liabilites
Current ratio = current assets / current liabilities
What are some examples of current assets?
- Cash
- Inventory
- Recievables
Why is it bad for a business to have such a high current ratio?
If a business has a current ratio above 2:1, they may be inefficient.
This is because the business will have significantly more current assets stored away to use to pay off liabilities than is needed.
These assets could be used for better things rather than being stored for no reason, leading to inefficiency
What are some examples of current liabilities?
- Overdrafts
- Payables
- Bank loans
- Leasing
What is considered to be a healthy current ratio for a business to have?
1.5:1 is a healthy current ratio for a business to usually have, meaning for every £1 the business has in liabilites, it has £1.50 set aside in assets to pay the liabilities.
If the number is less than 1:1 it means that the business has a bad current ratio as they have more liabilities than assets, making them insolvent.
What is the acid test ratio?
The acid test ratio is a tougher measure of liquidity than the current ratio as it takes away the inventory from current assets.
It assesses whether a business can cover current liabilities with just cash and recievables rather than inventory
Acid test ratio = current assets - inventory / current liabilities
What is the ideal ratio for the acid test ratio?
1:1 is the ideal number for the acid test ratio, as the value of the business’s assets are equal to it’s value of liabilities
What is working capital?
Working capital is the finance available for day to day spending.
It is the amount of cash that the business has available to pay its day to day debts.
Working capital = current assets - current liabilities
