Capital expenditure
Spending of a firms fixed assets
Fixed assets
Something a firm plan me to keep for longer than a year
Revenue expenditure
spending on a firms general operational costs
Examples:
- paying wages and salaries of workers
- paying suppliers
- utility bills
- repaying debts
- settling tax bills
Internal sources of finance
- Personal funds
- Retained profit - profit kept in the company rather than paid out to shareholders as dividends, money left over after expenses are paid
- Sale of assets - selling resources owned by the company which have economic value expressed in dollars.
External sources of finance
- Share capital - part of the capital that comes from the issuing or selling of shares
- Loan capital - money raised from loans but interest needs to be paid
- Overdrafts - when you can make a withdrawn for a greater amount then what’s in your bank account, a predetermined agreement
- Trade credit - the credit extended by supplies so you can buy now and pay later
- Grants - A financial reward given by the government that does not need to be paid back . It’s given to charitable organizations
- Subsides - a sum of something granted by the state to help an industry or business keep their price of a commodity or service low
- Debt factoring - when a company sells their debts / invoices to a factoring company for a reduced rate
- Leasing - a way of renting an asset that the business requires
- Venture capital - when companies invests in the business to receiver part ownership of the business to receive dividends
- Business angels - private individuals who invest their money into the business in return for ownership and dividends payments
Venture capital
when companies invests in the business to receiver part ownership of the business to receive dividends
Business angels
private individuals who invest their money into the business in return for ownership and dividends payments
Short term finance
Finance than is paid within 12 months
- trade credit
- debt factoring
- leasing
- subsides
Medium term finance
Finance that lasts longer than 1 year but shorter than 5
- loan capital
- leasing
- subsidies
Long term finance
Longer than 5 years
- grants
- share capital
- loan capital
- business angles
- venture capital
Internal source of finance
Money that is raised from the business’s existing assets
External sources of finance
Finance that comes from outside the business
Types of costs
- Fixed - costs does not change in relation to output
- salaries of staff
- insurance
- rent payments
- Variable - cost changes in direct relation to output
- materials
- packaging
- piece rate
- Semi variable - a cost composed of both fixed and variable costs
- Mobile phone bills - Direct - those only associated with a single part
- running costa of a single store
- staffing costs of a particular section
- Indirect / overhead - costs not directly accountable to a object, can be either fixed o variable
- national advertising campaigns
- salaries of the board of directors
Revenue
Calculation
Income from selling goods and services
Revenue = selling price x output
Revenue streams
All the different ways in which a business can generate sales
Movie revenue streams
- Food
- Tickets
Total contribution
How much the whole production line c tribute to covering fixed costs
£5 dollars to make the business and sells it for £7 = £2 contribution
Contribution per unit
How much a product contributes to covering fixed costs of a business
Break even chart
A business toll that is used to determine how many sales are needed to cover their total costs
Break even quantity
The level of output that generate sufficient revenue streams to cover total costs without any profit left
The amount of products a business has to sell to break even
Margin of safety
The difference between the break even point and the current level of output.
Break even formula
Fixed costs / contribution per unit
- lowest figure is desirable
- round up
Contribution per unit formula
Selling price - variable cost per unit
Total contribution formula
Contribution per unit x output
Margin of safety formula
Current level of output - break even point
Predicted profit formula
(Output x contribution per unit) - fixed costs
Advantages and Disadvantages of break even analysis
Benefits:
- quick and easy visual
- banks can ask for it to get loans
- strategic decision making tool
- allows companies to set targets
- calculate what is needed
Limitations:
- time consuming and each product needs a new graph
- it’s an assumption not 100% reliable
- assumes sales revenue is linear
- assumes all conditions remain the same
Internal stakeholders
- management
- shareholders and owners
- employees
External stakeholders
- government
- competitors
- suppliers
- media
- financiers
Principles of ethics of accounting practice
- ethics
- integrity
- objectivity
- professional behavior
- confidentiality
Parts of a profit and loss account
- a financial statement of a business’s financial activity usually over a year
- The trading account
- Profit and loss account
- Appropriation account
Explain the part 1 - Trading account
Sales revenue
Opening stock
Purchases
Closing stock
Cost of Good Sold (COGS)
Gross profit
Calculations
- COGS = purchases + opening stock - closing stock
- Gross profit = sales revenue - COGS
- Revenue = price x quantity
Gross profit
Profit made by a company after deducing COGS
COGS formula
Opening stock + purchases - closing stock
Gross profit formula
Sales revenue - COGS
Revenue formula
Price x quantity
Price elastic demand
A change in price greatly affects demand. A rise in price for this product decreases demand as its not essential.
- goods not necessaries
Price inelastic demand
Change in price does not affect demand as it’s an essential product
Ways to increase gross product
- negotiate lower prices from suppliers
- increase promotion
Net profit
The positive difference between a companies gross profit and its expenses
Net profit formula
Gross profit - expenses
Strategies to increase net profit
- rentals
- administrative staff salaries
- utilities
- office expenses
Part 2 - explain a profit and loss account
Sales revenue
Cost of goods sold
Gross profit
Less expenses
Net profit before tax
- interest
- net profit before tax
- less tax
Net profit after interest and tax
Part 3 - explain an appropriation account
Final part of an income statement showing how profits are distributed
Dividends and Retained profit are added under “net profit after interest and tax”
Retained profit
Profits not paid out as dividends but left in the reserve usually to be reinvested
Balance sheets
Statement showing the financial income of a business in term of assets, liabilities and owners equity at a particular point in time
It’s made up of three parts:
- Assets (what a business owns)
- Liabilities ( what a business owes)
- Owners equity (capital invested into the business)
Assets equation
Assets = liabilities + owners equity
Assets
Items owned by a firm, such as cash or buildings
Liabilities
Funds owned by a company to other institutions such as banks or suppliers
Equity
Funds invested in a business by the shareholders plus retained profits
Current assets
Fixed assets
Current assets - things that can be inverted into cash within 12 months
Examples:
- cash
- debtors
- stock
- liquid assets
Fixed assets - long term Ireland owned by a company that are not purchased for resale but to contribute to the operations of a business and have a lifespan over 12 months or are not sold within 12 months.
Examples:
- machinery
- equipment
- vehicles
- illiquid asset
Accumulated depreciation
Refers to a loss in value of fixed assets over time
Debtors
Individuals or institutions that owe money to a business
- assets
Stock or inventory
Unsold goods, raw materials that the company has at hand at the end of the trading period
Current liabilities
Funds a company owes to someone that should be paid within 12 months
Long term liabilities
Funds a company owes individuals that are paid over 12 months
Creditors
Individuals or organizations a business owes money to
- liability
Net current assets ( working capital) Formula
Current assets - current liabilities
Draw a balance sheet
- Company name
- Say it’s a balance sheet
- Date
Assets
Fixed assets
-
-
Less accumulated depression Net fixed assets Current assets - Cash - Debtors - stock Total current assets
-
Total current liabilities
Net current assets ( working capital)
Long term liabilities
Finances by:
Intangible assets
Non physical items of value owners by a firm that has a life span for over a year
Types of intangible assets
- Patents - legal protection given to an inventor of a product for a number of years
- Copyright - legal production given to producers of literacy and artistic such as music and books
- Brand - a distinguishable mark
- Registered trademark - distinctive mark that a company uses to identify itself
- Goodwill - Intangible value of a company derived from its “good nature” in business
Depreciation
Causes
The loss of value of fixed assets over time
Causes:
- wear and tear (damage)
- obsolescence (new versions)
Calculating depreciation = straight line method
- the assets will depreciate over a constant rate in its lifetime
- linear decrease
Formula:
Annual provision of depreciation = purchase price - residual value / estimates useful lifespan
Advantages:
- easy to calculate and apply
Disadvantages
- not accurate
Calculating depreciation = reducing / declining method
- fixed asset will decrease by the same percentage each year
- linear decreasing curve
“Decreases by 20% each time”
Advantages
- easy to apply and understand
- more realistic
Disadvantages
- subjective
Profitability and performance ratios
- gross profit margin - given formula
- net profit margin - given formula
- ROCE - half formula given
Gross profit margin
Formula given
Shows gross profit as a percentage of sales revenue. It indicates the profitability of the business’ core activities
Formula:
GPM = Gross profit margin / sales revenue x 100
Net profit margin
Formula given
Shows net profit as a percentage of sales revenue. Important ratio as it shows how well managers can control overhead expenses
NPM = net profit before tax and interest / sales revenue x 100
ROCE
Formula - half given, learn capital employed
Measures the efficient a form can return the money that was invested
ROCE = net profit before interest and tax / capital employed x 100
Capital employed = long term liabilities + share capital + retained profit
Capital employed formula
Capital employed = long term liabilities + share capital + retained profits
Liquidity ratios
Both formulas given
The firms ability to convert short term assets into cash
- current ratio
- Acid test ratio
Both formulas given
Current ratio
Formula given
Firms ability to pay off its short term debts using current assets
Current ratio = current assets / current liabilities
Acid test ratio
Formula given
Immediate indicator of a firms ability to pay its short term debts
Acid test ratio = current assets - stock / current liabilities
Efficiency ratios
Formulas given
- inventory / stock turnover - firms sells stock
- debtors days - number of days to collect the money
- creditor days - number of days to settle debts
- gearing ratio - how much of the business funding comes rom borrowed methods
Profit formula
Sales revenue - total costs
Net cash flow formula
Reasons for bad cash flow
Cash inflow - cash outflow
- poor pricing strategy
- low sales
- seasonal demand
- high expenses
- overstocking
- long credit collection
The working capital cycle
Formula
Is the time from the firms purchase of the stock to the production and sale of good and services and finally reviewing cash payment
Working capital = current assets - current liability
Working capital
- money to pay day to day expenses
A cash flow forecast
Is the prediction of future cash inflows, outflows and net cash flows for a specific period of time
Construct a cash flow forecast
- opening balance
- cash inflows
- total cash inflows
- cash outflows
- total cash outflows
- net cash flow
- closing balance
Strategies to deal with cash flow problems
- reducing cash outflow
- improving cash flows
- looking for additional finances
Investment
Purchasing assets that potentially yield future financial rewards
Investment opportunities
- payback period
- Average rate of return
Payback period
Formula
Calculates the length of time it takes for capital investment to pay for itself
- Payback period = Amount left to pay / net flow in that year x 12
(Net cash flow = cash inflows - cash outflows
The average rate of return (ARR)
Indicates the annual net return of an investment as a percentage of its capital lost
(Total returns- capital lost) / years of use / capital cost x 100 = _%
Net present value
Calculates the current value of a projects future cash flow
NPV = sum of present values - cost of investments
Budget
A tool to help financial planning and is used to set out plans for spending over a period of time
A profit center
Is a part of a business that contributes to its overall revenue
A cost center
Is a part of a business that incurs cost but does not contribute to its overall revenue
Variances
3 types
Formula
A tool used to compare business planned budget expenditure with the actual expenditure over a period of time
Favorable variance - things are better than expected
Adverse variance - things turned out worse than planned
No variance - thing turned out as planned
Variance = actual figure - budget figure
Benefits of budgeting
- planning
- motivation
- measuring performance
- communication
- coordination
- control
