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Finance Flashcards

1
Q

Why would it be important for a business to work out when it breaks even?

A

Calculate how many units to sell before making profit
Calculate effect on profit of increasing or decreasing price of a product
Calculate effect on profits of an increase/decrease in business costs
Work out level of output that must be produced and sold to earn revenue which exactly equals the total costs of producing that level of output (break even output)

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2
Q

What does a business need to know before producing a break-even chart

A

Revenue at 0 output at its maximum output (capacity)
Total cost at 0 output and at capacity output
Fixed costs at 0 output and at capacity output

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3
Q

What does a Break Even Chart do

A

Shows the effect of changes in the business’s revenue or costs
This is useful if a business decides to change its price/costs

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4
Q

Explain how to draw a break even chart

A

Step one: add fixed costs
- fixed costs line will always stay the same as they are not related to production at output
Step two: add total costs (fixed + variable)
Important:
- Label axis (x=output y= cost/revenue)
- Label BEP (point where total cost & revenue intersects)
- Draw lines with fixed & total cost & revenue

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5
Q

What is “Margin of Safety”

A

Amount of which actual sales exceed the break-even level of output

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6
Q

How do you work out the Margin of Safety

A

Actual sales - break even output

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7
Q

What is the point of determining a Margin of Safety

A

Measures amount which sales can fall before losses are made

Higher the margin of safety = lower the risk of a loss being made

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8
Q

List 4 advantages of using a Break Even Chart

A
  • Easy to construct and interpret
  • Provide businesses with useful information about output that must be sold to cover all costs and how different sales volumes affect the margin of safety and profitability
  • Can show the effect of a decision to change costs/revenues
  • Helps with other important business decisions (location/relocation of a business)
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9
Q

List 3 disadvantages of using a Break Even Chart

A
  • Assumes that all costs and revenues can be represented by straight lines
  • Not easy to separate costs into fixed and variable
  • Assume that all outputs is sold
  • > doesn’t allow for inventories and cost of holding these
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10
Q

What is “Interest Rate”

A

Cost of borrowing and the reward for saving

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11
Q

What is “Equity”

A

Capital

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12
Q

What are 6 reasons why a business might need to raise finance

A
  1. Start up, business needs money to pay for premises (buildings,), new equipment, and advertising
  2. Business needs money to pay staff wages and to produce stock
  3. Pay for longer factories or offices in different countries
  4. Research new products
  5. Money to pay for acquisition (purchase)
  6. More space/new technology to keep up with competitors/expansion
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13
Q

What is “Capital”

A

Cash or goods a business uses to generate outcomes (turns into profit)

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14
Q

What are 4 examples of internal finance

A
  • Retained profit: use profit as source of finance
  • Sales of assets: firms that can sell buildings to generate finance
  • Working capital: money available for immediate use to fund day-to-day operations (expenses/short-term debts)
  • Owner’s funds: sole trader/members of a partnership may put in more of their own money into the business
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15
Q

What is “Internal Finance”

A

Money obtained from within the business

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16
Q

What is “External Finance”

A

Money obtained from sources outside of the business

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17
Q

List 3 short term external sources of capital

A
  • Trade credit: business to business transactions are completed on a credit basis
  • Overdrafts: short term bank loan
  • Debt factoring: ‘selling’ a debt to a debt factoring company
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18
Q

List 4 long term external sources of capital

A
  • Bank loans
  • Sale & leaseback
  • Leasing
  • Venture capital
  • Grants
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19
Q

Explain what “Short Term Finance” means

A

Used to fund revenue expenditure and are usually repaid within one year
Time frame = less than one year
Shorter the time period, the higher rate of interest changed

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20
Q

Explain what “Long Term Finance” means

A

Used to fund capital expenditure & is usually repaid over a period longer than one year
Time frame = 5 years

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21
Q

List 4 examples of long term finance

A
  • Debenture: forms of long term loan to a limited company
  • Share issue: source of permanent capital available to limited liability companies
  • Hire purchase: the purchase of an asset by paying a fixed repayment amount
  • Leasing:Obtaining the use of a non-current asset by paying a fixed amount of time period over agreed time
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22
Q

What factors do businesses need to consider when they choose finance

A
  • Size and legal form of business: small businesses find it more difficult to borrow from banks & other lenders. Unable to pay back the amount given (unincorporated business) - difficult to raise finance by issuing shares
  • Amount required: Smaller amount might be financed through bank loans or leasing and hire purchase
  • Length of time: how long it will need the finance for
  • Existing borrowing: If a business already has existing borrowing, then it might have to borrow further amounts from banks/lenders
  • Risk involved
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23
Q

Define “Working Capital”

A

Money you use to run your business

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24
Q

How do you work out working capital

A

Current assets - current liabilities

25
Q

List the different stages of a working capital cycle (cash flow cycle)

A

Cash -> (credit/creditors [owe them]) -> purchases -> manufacture -> (storage) -> sales -> (debt/debtors [owe me]) -> cash

26
Q

Explain the working capital/cash flow cycle and how a business manages this

A

Cash: indicates what funds the business has available to continue to buy raw materials and pay for bills
Purchases: if a business has insufficient cash, it may choose to buy inventories using trade credit (buy now, pay later). This will often mean paying interest too
Manufacture: if a business produces too much stock and cannot sell it, the cash wasted
Sales: the longer the business has tow ait for payment, the less cash they have to operate, these are trade receivables. It is better for working capital if customers pay upfront in cash

  1. Identify problem
  2. Solve
    - Profit
    - Liquidity: more liabilities than assets
    Process: fix process issue
27
Q

Define “Cash flow problem”

A

Process of making cash slowing down or problems with profit/liquidity (current assets vs current liabilities)
- shipping/debtors/issues in manufacturing -> process issues
cash flow = profit = liquidity

28
Q

Define “Cash Flow Forecast”

A

An estimate of the future cash inflows and outflows of a business

29
Q

How can a business solve cash flow porblems

A
  • Arrange with bank to borrow money over time when a business has negative cash flow
  • Reduce some planned expenses
  • Increase forecasted cash income
  • > part-time job
  • Delay paying for some expenses until cash is available
  • > ask for credit on your purchases
30
Q

List 6 advantages of using a cash flow forecast

A
  • New business proposal won’t progress beyond initial planning stage unless investors and bankers have access to a cash-flow forecast and assumptions that lie behind it
  • How much is available for paying bills, repaying loans or for buying fixed assets
  • Whether the business is holding too much cash which could be put to a more profitable use
  • By showing negative cash flows, plans could be put in place to provide additional finance
  • > bank overdraft/preparing to inject more owner’s capital
  • If negative cash flow is too great, plans can be reduced
  • > cutting down on purchase of materials/machinery/not making sales on credit, only for cash
31
Q

List 5 disadvantages of using a cash flow forecast

A
  • Assumptions
  • Inaccurate
  • Mistakes can be made in preparing the revenue and cost forecasts or may be drawn up by inexperienced entrepreneurs or staff
  • Unexpected cost increases can lead to major inaccuracies in forecasts
  • Wrong assumptions can be made in estimating the sales of the business, perhaps based on poor market research
32
Q

What is the difference between profit and revenue

A

Profit is the reward for risk-taking (revenue - total cost)

Revenue = price * quantity sold

33
Q

Give the different parts of an income statement

A 
Sales (revenue)
Minus cost of sales
Gross profit
Minus expenses
Net profit
Minus tax
Profit after tax
Minus dividends/payouts
Retained profit (actual profit leftover)
34
Q

What is the difference between gross profit and net profit

A 
GP = Profitability of sales
NP = Profitability of my business
35
Q

How can a business use an income statement to make decisions both current and future

A
  • Increasing amount of revenue: higher profit
  • Order raw materials in bulk: reduces cost of raw materials company uses: benefits from lower costs
  • Use cheaper raw materials: reduces cost of sales
  • Improve production efficiency: cuts down waste (cost of business): more profit
  • Cut down on overheads: choosing cheaper electricity supplier
36
Q

Define “Asset”

A

Something that holds value, directly or use it to make money

37
Q

Define “Liability”

A

Expenses or financial responsibilities

38
Q

What is “Extrinsic value”

A

Implied value: value of something that a person can do with it

39
Q

What is “Intrinsic value”

A

Fundamental value: something is worth due to what it is

-> underneath the surface for the use of the object

40
Q

What is a “Fixed Asset”

A

Something that holds value that you don’t sell

Increases in value over time (building/house/land)

41
Q

What is a “Current Asset”

A

Holds value, uses it directly in the process of making money, or sell it directly in the process of making money (stock: bed in hotel)

42
Q

Label a balanced sheet

A

Fixed assets:
Fixed assets
(Depreciation)
Total fixed assets

Current assets:
Stock (things a business sells)
Debtors
Cash
Total:

Current liabilities::
Creditors
Overdraft
Total:

Working capital (expenses and short term debts)
Net Assets
-----------------------------------------------------------------------------------------
Financed by:
Share capital
Reserves (retained profit)
Long term loan
Capital employed

Important:
“Capital employed” and “net assets” must be equal to each other = balanced sheet

43
Q

What are the two profitability/financial ratios

A

Gross Profit Margin

Net Profit Margin

44
Q

How do you work out GPM

A

Gross profit/sales turnover (revenue) x100

45
Q

How do you work out NPM

A

Net profit/sales turnover (revenue) x100

46
Q

How do you work out gross profit

A

Sales - cost of sales

47
Q

How do you work out net profit

A

Total revenue - (Total variable cost + total fixed cost)

48
Q

How and why might a business use profitability ratios

A

Shows how much of the sales revenue the business turns into profit
- Turning the profit figures into a percentage of sales means that you can compare different businesses and year-on-year performance. The higher the percentage, the more profitable the business has been

49
Q

What are the two liquidity ratios

A

Current ratio

Acid test ratio

50
Q

How do you work out current ratio

A

Current assets/current liabilities (should be around 2)

2:1 is a good ratio

51
Q

How do you work out acid test ratio

A

Current assets-stock/current liabilities (should be around 1)
(1:1 is a good ratio)

52
Q

How and why might a business use liquidity ratios

A

Shows how easily the business can pay off its short-term debts
- Gives good indication of its working capital and cash

53
Q

Define “Profitability”

A

How well a business is making money

Difference between price and cost

54
Q

What is “R.O.C.E”

A

Return On Capital Employed
How much profit is earned for every dollar invested in the business
Amount of money that has been invested into the business that includes non-current liabilities and equity
(uses both income statement and balance sheet)

55
Q

How do you work out R.O.C.E

A

Net profit/capital employed x100

Larger % is better % as it shows how much profit the business has made as a percentage of that capital employed

56
Q

How and why might a business use R.O.C.E ratio

A

Most used measure of efficiency

- Considered to be the most important way of analysing a businesses’s profitability

57
Q

Why might internal stakeholders be interested in the company’s financial accounts

A

Owners:
- Profitability of business
- If they’re getting a good R.O.C.E
If business is running well

Shareholders:

  • Shows how much of their investment is turned into profit
  • Compare profits received from previous years

Managers:

  • If the business objective is reached
  • If profit of business is rising
  • How much they’re going to finance

Workers:

  • Job security: if profitability of business is high
  • Profit figures to support then claim for higher wages
58
Q

Why might external stakeholders be interested in the company’s financial accounts

A

Banks and lenders:
- Can know how much and when the business can pay back their loans

Government:

  • How much tax the business will pay
  • How much profit they’re earning

Competition:
- How much profit they make compared to them

Potential investors:
- Shows how much of their investment is turned to profit

Business (2 decks)

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