2.3 managing Finance

Question 1

What is profit?

Answer 1

The money left over after all costs have been accounted for

Question 2

What are the 3 different types of profit?

Answer 2

Gross profit: the difference between revenue and costs directly related to production (GP = revenue - cost of sales)

Operating profit: the difference between between the gross profit and the indirect expenses (business overheads that are non directly related to output such as salaries, rent and selling costs) involved in operating the business

(OP = gross profit - operating expenses)

Net profit: the difference between the operating profit and any interest and received as well as any one-off costs
(an exceptional cost), e.g.the purchase of a significant asset.

(NP = operating profit - net interest + exceptional costs)

Question 3

What is the statement of comprehensive income?

Answer 3

An end of year financial statement that shows all of a businesses income and expenses over the previous 12 months

Each type of profit is calculated within the statement of comprehensive income

The previous year’s figures are also shown for comparison purposes

Question 4

What is a profit margin?

Answer 4

The amount by which the sales revenue exceeds the costs

Profit margins can be calculated for each type of profit (gross, operating and net profit)

Question 5

What is gross profit margin?

Answer 5

The proportion of revenue that is turned into gross profit and is expressed as a %

Question 6

How is the gross profit margin calculated?

Answer 6

(Gross profit/revenue) x 100

Question 7

What is the operating profit margin?

Answer 7

Shows the proportion of revenue that is turned into operating profit and is expressed as a %

Question 8

How is the operating profit margin calculated?

Answer 8

(Operating profit/revenue) x 100

Question 9

What is net profit margin?

Answer 9

Shows the proportion of revenue that is turned into net profit before tax and is expressed as a %

Question 10

How is net profit margin calculated?

Answer 10

(Profit for the year/revenue) x 100

Question 11

How can profitability be improved?

Answer 11

• reducing one-off costs and interest, this could be done by implementing zero budgeting or leasing fixed assets
• reduce variable costs, this can be done by changing packaging, purchasing in bulk to gain economies of scale, or buying cheaper stock
• reduce expenses, this could be done by seeking new suppliers, reducing staff levels or relocating the business
• increase prices

Question 12

What is the difference between profit and cash?

Answer 12

Profit is the difference between revenue and business costs, whereas cash is the full range of money flowing in and out of a business

Question 13

What does the statement of financial position contain?

Answer 13

The financial information required to draw conclusions about the liquidity of the business.

It also shows the financial structure of a business at a specific point in time

It identifies a businesses assets and liabilities and specifies the capital (money) used to fund the business

The Statement of Financial Position is also known as the Balance Sheet

Question 14

What is liquidity?

Answer 14

The ability of a business to meet its short term commitments (e.g. payments to creditors) with its available assets

Managing liquidity is a key way to manage risk in a business - and helps a business to prepare for the unexpected

Question 15

What are non-current assets?

Answer 15

Items that are owned by a business for the long-term
E.g. machinery and buildings

Question 16

What are current assets?

Answer 16

Items that are converted to cash quickly
E.g. inventory

Question 17

What are current liabilities?

Answer 17

The money a business owes and is due to be settled soon - usually within 12 months
E.g. short term borrowing such as a bank overdraft

Question 19

What are non-current liabilities?

Answer 19

The money a business owes and that does not need to be payed back for at least 12 months
E.g. bank loans or mortgages

Question 20

How is net assets calculated?

Answer 20

Assets - liabilities

Question 21

What does the statement of financial position show?

Answer 21

How the net assets of a business are funded

Question 22

What is the total funding of a business known as?

Answer 22

The capital employed

Net assets = capital employed

Question 23

What are the 2 ways of measured liquidity?

Answer 23

The current ratio:
Quick way to measure liquidity
Effective liquidity measure for businesses that hold little stock.
The result indicates how many pounds of current assets it has available to cover each 1 pound of short term debt

The acid test ratio:
The least liquid form of current assets (inventory/stock) is deducted so the acid test ratio provides a more realistic measure of the businesses ability to meet short-term debts quickly. Effective liquidity measure for businesses that hold large amounts of stock

Question 24

How is the current ratio calculated?

Answer 24

Current assets/current liabilities

Question 25

How is the acid test ratio calculated?

Answer 25

(Current assets - inventory)/current liabilities

Question 26

What are the methods to improve liquidity?

Answer 26

Reduce the credit period offered to customers: Collecting money owed from customers more quickly will increase the level of current assets in the business Ask suppliers for an extended repayment period e.g. from 60 to 90 days: The business can use cash it would have paid to suppliers for other purposes Make use of overdraft facilities or short-term loans Sell off excess stock Sell assets and lease fixed assets instead Introduce new capital and reducing the amount of money taken out the business: New capital could be gained from additional investors

Question 27

What is working capital?

Answer 27

The money that a business has to fund its day to day activities

Question 28

How is working capital calculated?

Answer 28

Current assets - current liabilities

Question 29

What happens if a business has a lack of working capital?

Answer 29

It usually leads to business failure as a business cannot meet its immediate financial obligations

Question 30

What is the most liquid form of assets?

Answer 30

Cash

Question 31

What may businesses that are struggling with a lack of working capital do?

Answer 31

Convert their current assets into cash as quickly as possible E.g. by selling stock at lower prices or by purposefully chasing payments from customers

Question 32

What are the implications of a business having too much working capital?

Answer 32

If a business is holding large amounts of cash it is likely to be missing out on the benefits of investing it into fixed assets and investments This may represent a significant opportunity cost especially when interest rates are high

Question 33

What are the internal reasons for business failure?

Answer 33

Poor planning: lack of research and development, so little innovation. Poor budgeting. Ineffective business plan Lack of leadership: poor decision making, failure to delegate Ineffective marketing: not enough or inappropriate market research, poor understanding of customer needs. Cash flow problems Lack of funds: difficulties in borrowing, limited owner capital, failure to attract investment

Question 34

What are the external reasons for business failure?

Answer 34

Economic challenges: business failures increase during periods of recession due to reduced demand. Rising interest rates increase business costs Changes in consumer tastes: dated stock may be unsellable Legal factors: products or assets may need to be replaced or redesigned to meet changed legal standards. Laws can increase staffing and transport costs e.g. minimum wage. Market challenges: competitors undercut prices to gain market share. Market selling prices may be too low to achieve break even Technological change: significant capital spending is needed to replace obsolete non-current assets. Product innovation leads to the disappearance of a businesses market