Business Finance

Question 1

Why do Businesses need Finance?

Answer 1

Question 2

What are Short-term Finance Needs?

Answer 2

Finance is needed by business to meet short-term and long-term liabilities and to fund day to day activities

Short-term sources of finance are needed to meet day to day costs such as paying bills, suppliers and employee wages
They are likely to be relatively small amounts and are rarely needed beyond a year

Where revenue from sales does not cover these expenses sources such as overdrafts or trade credit may be useful

Question 3

What are Long-term Finance Needs?

Answer 3

Longer-term sources of finance are needed to fund the purchase of non-current assets such as buildings and other types of capital resources or to acquire other businesses
These are likely to be large sums that may be required for a significant period of time

Where retained profit is not sufficient to meet these needs businesses may consider taking out long-term loans, mortgages or raising share capital

Question 4

What is a Start-up Finance?

Answer 4

Start-up finance is needed by a new business to pay for fixed assets and current assets such as stock before it can begin trading

The amount of start-up finance a business needs is identified in the business plan
Owners often invest their own capital into a new business
Some small new business owners obtain a start-up loan to cover initial costs

Question 5

What is an internal source of finance ?

Answer 5

An internal source of finance is money that comes from within a business

Question 6

What are the main sources of internal finance ?

Answer 6

1- Personal savings - Money saved up by a businesses owner and invested into their own enterprise

2- Retained profit - Profit made in previous years that is available to reinvest in a business

3- Sale of Assets - Money from the sale of equipment, vehicles land, buildings or reduced-price inventory

Question 7

What are advantages and disadvantages of internal sources of finance ?

Answer 7

Advantages - Internal finance is often free (e.g. it does not involve the payment of interest or charges)

It does not involve third parties who may want to influence business decisions

Internal finance can often be organised quickly and without significant paperwork

Businesses that may fail credit checks (necessary for a bank loan) can access internal finance sources more easily

Disadvantages - There is a significant opportunity cost involved in the use of internal finance, e.g. once retained profit has been used, it is not available for other purposes

Internal finance may not be sufficient to meet the needs of the business

Using an internal finance method is rarely as tax-efficient as many external methods, e.g. loan repayments may be treated as a business cost and offset against tax

Question 8

What is an external source of finance ?

Answer 8

An external source of finance is money that is introduced into the business from outside
External finance is used when a business cannot fulfil its needs with internal sources of finance

Question 9

What are the main sources of external finance ?

Answer 9

Question 10

What are overdrafts and trade credit?

Answer 10

An overdraft is a flexible arrangement for a business current account holder to spend more money than they have in their account
A limit is agreed and interest is charged only when a business ‘goes overdrawn
Overdraft users are typically charged interest at a daily rate
Using an overdraft for a long period can therefore be expensive compared to other methods

An overdraft may be ‘called in’ if the bank is concerned about a business’s ability to repay what it owes
Some large businesses rely heavily on overdrafts to manage working capital

Trade credit is where a business has an agreement to delay paying suppliers for a typical period of 30 to 90 days
This helps to improve the cash flow position of the business
Trade credit is usually interest-free
Large businesses tend to be able to request more generous trade credit terms from suppliers than small businesses
Businesses using trade credit may miss out on early payment discounts

Question 11

What is a finance from loans ?

Answer 11

A sum of money is borrowed from a bank or other financial provider and repaid with a fixed interest rate over a specific period of time
The loan application must be approved before funds are transferred to the business
This may require a convincing business plan containing financial forecasts
Some financial providers demand collateral before a loan is granted

Long-term loans, known as mortgages, are used to fund the purchase of property
Repayment is typically over 25 or more years
Mortgages can have fixed or variable interest rates

Question 12

What are finance from selling shares ?

Answer 12

A private limited company can raise finance by selling shares to friends, family or private investors such as business angels

Public limited companies can raise large amounts of finance through the initial sale of shares during stock market flotation or through a rights issue

Debentures are long-term loan certificates issued by limited companies to shareholders
Debentures must be repaid with a fixed rate of interest to lenders

Question 13

What is a venture capital ?

Answer 13

Venture capital is sometimes available to businesses that are deemed too risky for other investors or lenders but are considered to have long-term growth potential

It generally comes from specialist businesses and banks that look to maximise their return on investment
Venture capitalists may invest technological expertise, financial advice and management experience in return for a share in the business
Their investment is usually made for a fixed period of time, typically four to six years

Question 14

What is crowdfunding ?

Answer 14

Crowdfunding allows businesses to access finance provided by a large number of small investors on online platforms such as Kickstarter and Fundable
Investments are voluntary donations that do not have to be repaid and do not attract a dividend
The business has to reach a target amount before any funds are released
They receive no funding if the investment target is not met by a set date

Crowdfunders do not own a share of the business
They are often attracted by incentives such as a sample or early access to a product

Flow Hive is a beekeeping system that was successfully funded on Indiegogo in 2015
Its crowdfunding campaign raised $12.2 million from 38,470 backers

Question 15

What are factors affecting the choice of finance ?

Answer 15

Question 16

What are short term and long term sources of finance ?

Answer 16

Question 17

What is the purpose of cash?

Answer 17

Cash is the ‘lifeblood’ of a business as without it a business will likely become insolvent relatively quickly
It is the most liquid form of current asset in the form of notes and coins on a businesses premises as well as money deposited in the bank

Question 18

Compare cash and profit .

Answer 18

Profit and cash are different financial terminologies
Profit is calculated at a specific point in time
While a business may ultimately make a profit, they may lack cash at times because some customers may not actually have paid them yet

Profit is the difference between revenue generated and total business costs during a specific period of time
Profit can be an important indicator of a company’s financial health and long-term sustainability as it helps to assess the effectiveness of a company’s operations

Question 19

What are cash inflows and outflows ?

Answer 19

Cash inflows are sums of money introduced to the business
Examples include money earned from sales, monies received such as loans or owners’ capital and interest from investments

Cash outflows are sums of money leaving the business
Examples include payments to suppliers, wages and salaries, loan repayments and advertising expenses

The difference between cash inflows and cash outflows during a period of time is known as the net cash flow

Question 20

What is a cash flow Forecast ?

Answer 20

A cash flow forecast is a prediction of the anticipated cash inflows and cash outflows, usually for a six to twelve month period

A business plan should include a cash flow forecast
Business owners can identify its financial needs
Lenders such as banks can determine whether loans are capable of being repaid

Question 21

What are the uses and limitations of cash flow forecasts?

Answer 21

Question 22

Complete the cash flow forecast to show

a. Total cash outflows for March

b. Closing balance for March

c. Wages for May

d. Net cash flow for May [4 marks]

Answer 22

Step 1: Add all of March’s cash outflows to calculate the total

Total space Outflows space for space March space equals space 13 comma 000 space plus space 28 comma 000 space plus space 3 comma 500 space

equals space 44 comma 500 [1 mark]

Step 2: Add the opening balance to the net cash flow to calculate March’s closing balance

begin mathsize 16px style Opening space Balance space plus space Net space Cash space Flow space equals space Closing space Balance

equals space 4 comma 000 space plus space 1 comma 500 space

equals space 5 comma 500
end style [1 mark]

Step 3: Subtract inventory and miscellaneous outflows from total cash outflows to calculate wages

Wages space for space May space equals space 48 comma 000 space minus space 13 comma 000 space minus space 4 comma 000

equals space 31 comma 000 [1 mark]

Step 4: Subtract total cash outflows from total cash inflows to calculate net cash flow

Total space Cash space Inflows space minus space Total space Cash space Outflows space equals space Net space Cash space Flow

equals space 61 comma 000 space minus space 48 comma 000

equals space 13 comma 000 [1 mark]

Question 23

What are some ways to solve cash flow problems ?

Answer 23

Question 24

What is revenue ?

Answer 24

Revenue is the value of the units sold by a business over a period of time
E.g the revenue earned by Apple Music from sales of music downloads

Question 25

What is the formula for Revenue?

Answer 25

Revenue = Quantity sold x Selling price Revenue usually increases as the sales volume increases Revenue should not be defined as 'money earned' as businesses can receive earnings from investments such as savings

Question 26

Fotherhill Organics Limited sold 39,264 packs of its specialist compost to mail-order customers in 2022. The price per pack was £8.75. In addition, it sold 4,275 tonnes to gardening businesses for £123.95 per tonne. Calculate Fotherhill Organics revenue for 2022 [3]

Answer 26

Step 1: Calculate the revenue from sales to mail-order customers 39,264 x £8.75 = £343,560 [1 mark] Step 2: Calculate the revenue from sales to gardening businesses 4,280 x £123.95 = £530,506 [1 mark] Step 3: Add the two revenue figures together £343,560 + £530,506 = £874,066 [1 mark]

Question 27

What is fixed variable & total costs ?

Answer 27

n preparing goods/services for sale, businesses incur a range of costs Some examples of these these costs include purchasing raw materials, paying staff salaries and wages, and paying utility bills such as electricity These costs can be broken into different categories Fixed costs (FC) are costs that do not change as the level of output changes These have to be paid whether the output is zero or 5000 E.g. building rent, management salaries, insurance, bank loan repayments etc. Variable costs (VC) are costs that vary directly with the output These increase as output increases & vice versa E.g. raw material costs, wages of workers directly involved in the production Total costs (TC) are the sum of the fixed + variable costs

Question 28

What is profit & loss?

Answer 28

Profit is a surplus that remains after business costs have been subtracted If costs exceed revenue the business makes a loss Most businesses have the main objective of making a profit Profits help new businesses to survive and break-even It is a reward for risks taken by entrepreneurs and investors Established businesses can use profit to fund long-term growth

Question 29

What is the most simple formula for calculating profit?

Answer 29

Profit = Revenue - total cost

Question 30

How is profit made ?

Answer 30

Question 31

In 2022 Fotherhill Organics Limited achieved revenue of £874,066 from sales of its specialist compost. In addition, it incurred total costs of £578,033 Calculate Fotherhill Organics profit for 2022 [1]

Answer 31

Step 1: Subtract total costs from revenue = £ 874,066 - £ 578,033 = £296,033

Question 32

What is the break even point ?

Answer 32

The break even point is the number of units a business must sell to reach the point where revenue is equal to total costs At the break even point neither a loss nor a profit is made It helps businesses understand the minimum level of sales or output they need to achieve in order to cover all costs This helps business managers to make informed decisions about pricing and production volumes Calculation of the break even point requires three elements

Question 33

What are the 3 elements of the break even analysis ?

Answer 33

Question 34

What are fixed costs ?

Answer 34

Fixed costs are costs that do not change regardless of the level of production or sales E.g. rent, salaries and insurance

Question 35

What are variable costs?

Answer 35

Variable costs are costs that vary with the level of production or sales E.g. raw materials, direct labour costs, packaging and shipping costs

Question 36

What is a Revenue ?

Answer 36

Revenue is the money earned from selling products/service and is calculated using the formula Revenue = Quality sold x selling price .

Question 37

How do you calculate the break-even point ?

Answer 37

Question 38

Answer 38

Question 39

What is the statement of comprehensive income ?

Answer 39

A statement of comprehensive income records the income and costs of a business incurred over a period of time (usually one year) It is also known as a profit-and-loss account or income statement It is one of the key financial statements provided in the annual report

Question 41

What are two profits that are calculated in the income statement ?

Answer 41

Gross profit is made when revenue is greater than the cost of sales Calculated by Revenue - Cost of Sales Revenue is money generated through selling goods and services Calculated by Quantity sold x Selling price Cost of Sales is the cost of raw materials and labour used in producing or buying in the goods actually sold by the business during a time period Calculated by Variable Cost per unit x Quantity Sold In 2023, Toys & Trikes Ltd earned revenue of $274,000 and its cost of sales was $169,000 Gross Profit was therefore $274,000 - $169,000 = $105,000 Operating Profit Operating profit is profit made by a business after all costs have been deducted from revenue Calculated by Gross Profit - Expenses Expenses are costs that are not directly related to the production of goods or purchasing stock for sales In 2023, Toys & Trikes Ltd made a gross profit of $105,000 and had expenses of $48,000 Operating Profit was therefore $105,000 - $48,000 = $57,000

Question 42

What is the statement of financial position ?

Answer 42

The Statement of Financial Position shows the financial structure of a business at a specific point in time It is included as a key financial statement in the annual report It identifies a businesses assets and liabilities and specifies the capital (equity) used to fund the business operations The Statement of Financial Position is also known as the Balance Sheet It is called the balance sheet as the net assets are equal to the total equity

Question 43

What are assets ?

Answer 43

Assets are items that are owned by a business Two types of assets appear in the statement of financial position Non-Current Assets are items owned by the business in the long-term Examples include tangible assets such as buildings, land, machinery and vehicles Non-current assets may be intangible such as patents, goodwill or brand value Current Assets include cash and items that can be turned into cash relatively quickly, usually within 12 months The four types of current assets are cash in hand, cash in bank, trade receivables and inventory

Question 44

What are liabilities ?

Answer 44

Liabilities are items that are owed by a business Two types of liabilities appear in the statement of financial position Current Liabilities are short-term financial obligations that a business must usually pay within one year, or as demanded by its creditors E.g. Trade payables and bank overdrafts Non-current Liabilities are moneys owed by a business that are due to be repaid over a period longer than twelve months E.g. Long term loans and mortgages

Question 45

Draw a diagram of financial position .

Answer 45

Liabilities are items that are owed by a business Two types of liabilities appear in the statement of financial position Current Liabilities are short-term financial obligations that a business must usually pay within one year, or as demanded by its creditors E.g. Trade payables and bank overdrafts Non-current Liabilities are moneys owed by a business that are due to be repaid over a period longer than twelve months E.g. Long term loans and mortgages

Question 46

How do you interpret the statement of financial position ?

Answer 46

Financing its activities What the business owns What the business owes

Question 47

What are profit Margins ?

Answer 47

Profit margins measure of how effectively a business converts revenue into profit Profit margins can be compared to previous years' to better understand business performance Higher and increasing profit margins are preferable, as it means that more revenue is being converted to profit

Question 48

What is the gross profit margin ?

Answer 48

Question 49

Head to Toe Wellbeing’s revenue in 2022 was $124,653. Its gross profit was $105,731 Calculate Head to Toe Wellbeing Ltd’s Gross Profit Margin in 2022 [2 marks]

Answer 49

Question 50

How are some ways to increase the gross profit margin ?

Answer 50

Question 51

What is the operating profit margin ?

Answer 51

Question 52

What is ratio analysis ?

Answer 52

Ratio analysis involves extracting information from financial accounts to assess business performance

Question 53

What are profit margins ?

Answer 53

Profit margins measure of how effectively a business converts revenue into profit Profit margins can be compared to previous years' to better understand business performance Higher and increasing profit margins are preferable, as it means that more revenue is being converted to profit

Question 54

What is the gross profit margin ?

Answer 54

This calculation shows the proportion of revenue that is turned into gross profit It is calculated using the following formula and is expressed as a percentage Gross Profit Margin = Gross profit divided by Revenue x 100

Question 55

How do you improve the gross profit margin ?

Answer 55

The gross profit margin can be improved in two ways The business can increase its sales revenue The business can reduce its direct costs

Question 56

How do you increase the gross profit margin ?

Answer 56

Question 57

What is the operating profit margin ?

Answer 57

This calculation shows the proportion of revenue that is turned into operating profit It is calculated using the formula below and the outcome is expressed as a percentage Operating Profit Margin = operating profit divided by revenue x 100

Question 58

How do you improve the operating profit margin ?

Answer 58

The profit margin can be improved in two ways Increase the gross profit margin (see above) Reduce expenses by cutting staffing levels, relocating to cheaper premises or changing utility companies Reducing staffing levels may affect staff morale and negatively affect productivity Relocation costs may outweigh some of the benefits of moving to a cheaper location Replacing inefficient or outdated equipment may require staff training

Question 59

What is a mark-up ?

Answer 59

The mark-up is a measure of profit made on each item sold Some businesses calculate the markup in order to determine the price at which they should sell their products This methods ensures that all costs are covered and that a profit will be made on every item they sell Mark-up is expressed as a percentage and calculated using the formula Markup = Profit per item divided by Cost per item x 100

Question 60

What is ratio analysis ?

Answer 60

Ratio analysis involves extracting information from financial accounts to assess business performance .

Question 61

What does ratio analysis help manage ?

Answer 61

t helps managers to answer key questions including Why is one business more profitable than another one in the same industry? Is a business growing? How effectively is a business using assets and capital invested? What return on investment is expected? How risky is the financial structure of the business?

Question 62

How do you increase gross profit margin ?

Answer 62

Question 63

What is the operating margin formula ?

Answer 63

Question 64

Head to Toe Wellbeing’s revenue in 2022 was $124,653. Its gross profit was $105,731 Calculate Head to Toe Wellbeing Ltd’s Gross Profit Margin in 2022 [2 marks]

Answer 64

Question 65

How can you improve the operating profit margin ?

Answer 65

The profit margin can be improved in two ways Increase the gross profit margin (see above) Reduce expenses by cutting staffing levels, relocating to cheaper premises or changing utility companies Reducing staffing levels may affect staff morale and negatively affect productivity Relocation costs may outweigh some of the benefits of moving to a cheaper location Replacing inefficient or outdated equipment may require staff training

Question 66

What is mark-up ?

Answer 66

The mark-up is a measure of profit made on each item sold

Question 67

What is the mark-up formula?

Answer 67

Question 68

Evolve Boards' bestselling penny skateboard costs $12.13 to produce. Each board is sold for $20. Calculate the percentage markup on each penny skateboard sold [2 marks]

Answer 68

Question 69

What is Return on capital employed?

Answer 69

The Return on Capital Employed (RoCE) measures how how effectively a business uses the capital invested in the business to generate profit

Question 70

What is the return on capital employed formula ?

Answer 70

Question 71

What is the capital employed formula ?

Answer 71

Question 72

The table shows an extract from the company accounts of Keals Cosmetics. Non-current Liabilities €1.5 million Revenue €7 million Equity €15.4 million Operating Profit €2.2 million Calculate Keals Cosmetics' Return on Capital Employed. [3 marks]

Answer 72

Question 73

How do you improve RoCE?

Answer 73

When analysing the RoCE, the higher the rate the better, as it indicates that the business is profitable and using its capital efficiently Investors prefer businesses with stable and rising levels of RoCE, as this indicates low-risk growth is being achieved To increase the RoCE, a business can Increase the level of profit generated without introducing new capital into the business Maintain the level of profit generated whilst reducing the amount of capital in the business

Question 74

Faced with increasing costs, Kent & Medway Properties Ltd is looking to close one of its three high street real estate branches. The table below shows some key data for each of the branches. Branch Capital Employed Operating Profit Sevenoaks £2.4m £0.37m Whitstable £3.1m £0.57m Rochester £2.9m £0.51m Calculate the Return on Capital Employed (RoCE) for each branch and recommend which branch, on profitability terms, should close

Answer 74

Question 75

What is the importance of liquidity ?

Answer 75

Liquidity is defined as the ability of a business to pay back its short-term debts, e.g. its suppliers A businesses that cannot pay its debts is considered insolvent If a business cannot pay its suppliers, raw materials or components may not be delivered and production will be delayed If it cannot repay an overdraft, banking facilities may be withdrawn, and its credit rating will suffer Creditors may force it to stop trading and sell its assets so that the debts owed to them are repaid Stakeholders interested in liquidity include Suppliers want to be reassured that a business is likely to be able to pay for them Financial providers such as banks want evidence that a business is likely to be able to repay loans or overdrafts Customers want to be sure that a supplier will be able to produce and deliver goods it orders

Question 76

Which 2 rations can be used to measure the liquidity of a business ?

Answer 76

Current ratio Acid test ratio

Question 77

What is the current ratio ?

Answer 77

The Current Ratio is a quick way to measure liquidity The outcome is expressed as a ratio All types of current asset are included in calculating this ratio The result indicates how many £s (or other currency units) of current assets are available to cover each £1 (or other currency unit) of short-term debt

Question 78

Packer Sports Ltd has current assets of $15,545, current liabilities of $5,060 and an inventory figure of $8,250. Calculate Packer Sports Ltd.’s current ratio. [2]

Answer 78

Question 79

What is the Acid test ratio ?

Answer 79

The acid test ratio is a precise and realistic way to measure liquidity, especially for businesses that hold large amounts of inventory It is expressed as a ratio It is also known as the liquid capital ratio The least liquid form of current assets (inventory) is deducted so the acid test ratio provides a more realistic measure of the businesses ability to meet short-term debts quickly It often takes time to sell inventory so it is excluded

Question 80

Packer Sports Ltd has current assets of $15,545, current liabilities of $5,060 and an inventory figure of $8,250. Calculate Packer Sports Ltd’s acid test ratio. [3]

Answer 80

Question 81

How do you improve liquidity ?

Answer 81

Question 82

How do stakeholders use financial documents ?

Answer 82

Question 83

What decisions can be used using financial statements ?

Answer 83

Question 84

What is an investment ?

Answer 84

The statement of comprehensive income can show whether a business can afford to purchase new non-current assets such as machinery, property or vehicles The impact of spending on research and development or overseas growth on costs and revenues can be determined

Question 85

What is financing ?

Answer 85

The impact on the statement of financial position of taking out loans or other credit can be determined The statement of financial position also identifies the value of share capital and retained profit

Question 86

What is improving profit ?

Answer 86

Ratio analysis can identify the impact of different types of cost on the businesses ability to generate profit The impact of increased prices on sales revenue can be identified in the statement of comprehensive income

Question 87

How do you manage assets ?

Answer 87

The impact of leasing assets rather than owning them can be seen in both key financial documents Investment in non-current assets can be compared to investment in human resources to determine whether capital-intensive or labour-intensive production is most suitable Deciding whether to continue to maintain equipment or dispose of it can be determined by considering costs and revenues in the financial documents