Section 5 - Financial information and financial decisions

Question 0

What are Cash Inflows

Answer 0

Cash inflows are the sums of money received by a business during a period of time (also known as reciepts)

Question 1

Define Cash Flow

Answer 1

The cash flow of a business is the cash inflows and outflows over a period of time

Question 2

What are Cash Outflows?

Answer 2

Cash outflows are the sums of money paid out by a business during a period of time (also known as payments)

Question 3

What is a Cash Flow Cycle?

Answer 3

A cash flow cycle shows the stages between paying out cash for labour, materials, etc. and receiving cash from the sale of goods.

Question 4

Define Profit

Answer 4

Profit is the surplus after total costs have been subtracted from sales revenue.

Question 5

What is a Cash Flow Forecast?

Answer 5

A cash flow forecast is an estimate of future cash inflows and outflows of a business, usually on a month-by-month basis. This then shows the expected cash balance at the end of the month.

Question 6

What is the Opening Cash Balance? (also known as the Opening Bank Balance)

Answer 6

The opening cash balance is the amount of cash held by the business at the start of the month.

Question 7

Define Net Cash Flow

Answer 7

Net cash flow is the difference, each month, between inflows and outflows.

Question 8

What is the Closing Cash Balance? (also known as the Closing Bank Balance)

Answer 8

The closing cash balance is the amount of cash held by a business at the end of each month. This becomes next month’s opening cash balance.

Question 9

Define Working Capital

Answer 9

Working capital is the capital available to a business in the short term to pay for day-to-day expenses.
Working Capital = Current Assets - Current Liabilities

Question 10

What are Accounts?

Answer 10

Accounts are the financial records of a firm’s transactions.

Question 11

What do Accountants do?

Answer 11

Accountants are the professionally qualified people who have responsibility for keeping accurate accounts and for producing the final accounts.

Question 12

What are Final Accounts?

Answer 12

Final accounts are produced at the end of the financial year and give details of the profit or loss made over the year and the worth of the business.

Question 13

What is an Income Statement?

Answer 13

An Income Statement is a document that records the income of a business and all costs incurred to earn that income over a period of time (for example one year). It is also known as a profit and loss account.

Question 14

Define Sales Revenue

Answer 14

The sales revenue is the income to a business during a period of time from the sale of goods or services.

Question 15

Define Cost of Goods Sold

Answer 15

The cost of goods sold is the cost of producing or buying in the goods actually sold by the business during a time period.
Cost of Goods Sold = Opening Inventories + Purchases - Closing Inventories.

Question 16

What is Gross Profit?

Answer 16

A gross profit is made when sales revenue is greater than the cost of goods sold.
Gross Profit = Sales Revenue - Cost of Goods Sold
(Note: Gross profit does not make allowance for over head costs or expenses)

Question 17

What is a Trading Account?

Answer 17

A trading account shows how the gross profit of a business is calculated.

Question 18

What is Net Profit?

Answer 18

Net Profit is the profit made by a business after all costs have been deducted from sales revenue.
Net Profit = Gross Profit - Overhead costs

Question 19

Define Depreciation

Answer 19

Depreciation is the fall in value of a fixed asset over time.

Question 20

What is Retained Profit

Answer 20

Retained profit is the net profit reinvested back into a company, after deducting tax and payments to owners, such as dividens.
Retained Profit = Net Profit - Tax - Dividends

Question 21

What is a Balance Sheet?

Answer 21

The balance sheet shows the values of a business’s assets and liabilities at a particular time. Sometime referred to a as ‘statement of financial position’.

Question 22

What are Assets?

Answer 22

Assets are those items of value which are owned by the business. They may be fixed (non-current) or short-term current assets.

Question 23

Define Liabilities

Answer 23

Liabilities are debts owned by the business.

Question 24

What are Non-Current Assets?

Answer 24

Non-current assets are items owned by the business for more than one year. (Not Liquid)

Question 25

What are Current Assets?

Answer 25

Current Assets are owned by a business and used within one year. (Liquid)

Question 26

What are Non-Current Liabilities?

Answer 26

Non-current liabilities are long-term debts owed by the business.

Question 27

What are Current Liabilities?

Answer 27

Current liabilities are short-term debts owed by the business.

Question 28

What is Liquidity?

Answer 28

Liquidity is the ability of a business to pay back its short terms debts.

Question 29

What is Capital Employed?

Answer 29

Capital Employed is the total long-term and permanent capital invested in a business. Capital Employed = Non-Current Liabilities + Shareholders' Equity This helps figure out a businesses gearing.

Question 30

What does is mean if an asset is Illiquid?

Answer 30

Illiquid means that assets are not easily convertible into cash.

Question 31

What is Capital Expenditure?

Answer 31

Capital Expenditure is money spent on assets that will last for longer than one year. (Non-current assets) For example, equipment.

Question 32

What is Revenue Expenditure?

Answer 32

Revenue expenditure is money spent on day-to-day expenses. For example, rent or wages.

Question 33

Define Insolvency

Answer 33

Insolvency is when a business runs out of cash even though it is profitable. (Remember, cash flow is not profit!)

Question 34

Who is the Creditor?

Answer 34

During a trade credit transaction, the creditor is owed money by the business. Also known as the accounts payable. (CREDITORS = SUPPLIERS; DEBTORS = CUSTOMERS)

Question 35

Who is the Debtor?

Answer 35

During a trade credit transaction, a debtor owes the company money. (CREDITOR = SUPPLIERS; DEBTOR = CUSTOMERS)

Question 36

Return on capital employed

Answer 36

For every dollar put into the business, what proportion of that do you get back. (Out of 100) Net profit/ Capital employed * 100

Question 37

Gross profit margin

Answer 37

For every dollar of sales revenue, how much is gross profit. | Gross Profit/ sales revenue * 100

Question 38

Net profit margin

Answer 38

For every dollar of sales revenue you make, how much is net profit. Net profit/ sales revenue * 100

Question 39

How to check how a business is performing

Answer 39

Compare this year with last year | Compare to other businesses

Question 40

Current ration

Answer 40

How easily you can pay off short term debts. Current assets / current liabilities. If this number is below 1, then it means that you are not able to pay off your short term debts. If this number is above 2, then it means you are not investing enough into the business.

Question 41

Acid test ratio/ liquidity

Answer 41

Truer test of liquidity than current ratio because inventory is not included. Inventory cannot always be sold so easily. (Current assets - inventory) / current liabilities If this number is below 1, then it means that you are not able to pay off your short term debts. If this number is above 2, then it means you are not investing enough into the business.

Question 42

solvency

Answer 42

Solvency is your ability to pay off you short term liabilities. If you can, your business is solvent. If you can't, your business is insolvent.

Question 43

Reasons for low liquidity ratios

Answer 43

Haven't paid for supplies that have already been used causing debt. The business has used cash to pay for fixed assets.

Question 44

Limitations of ratio analysis

Answer 44

External users will only be able to use published accounts which have less information. Ratios are based on the past and thus the future is difficult to extrapolate. The data is affected by inflation and other factors in the long term. Different companies use different methods of calculation so you may get different answers.

Question 45

What is liquidity?

Answer 45

Liquidity is the ability of a business to pay back short term debts. Can also mean the amount of available cash. If a business can't repay short term debts or overdrafts then it is illiquid.

Question 46

Who uses the data from profitability ratios?

Answer 46

Managers - to keep control, help in decision making, to prevent depreciation. Shareholders - to know whether or not they will be able to make a profit Creditors - want to know whether or not you are trustworthy to pay back money (CREDITORS IS SUPPLIERS; DEBTORS IS CUSTOMERS) Banks - want to know if you will be able to pay back long term loans Government - want to know if your losses will hurt the economy or lead to unemployment. Workers/ trade unions - want to know if their jobs are secure Competitors - want to compare their performance or consider takeovers

Question 47

Start up capital

Answer 47

the finance needed by a new business to pay for essential fixed and current assets

Question 48

Source of finance: retained profit

Answer 48

profit kept in the business after the owners have taken their share of the profits. Also called ploughed back profit. (Internal) +Doesn't have to be repaid +No interest -not available for new businesses -too little for small firms -keeping profits reduces dividens

Question 49

Source of finance: sale of existing assets

Answer 49

Existing assets that could be sold are those items of value which are no longer required by the business eg redundant buildings (internal) +better use of capital +doesn't increase debt -may take time to sell asset -not available for new businesses -what kind of business just HAPPENS to have redundant buildings?????

Question 50

source of finance: sale of inventory

Answer 50

Selling inventory to reduce inventory. (internal) +reduces opportunity cost and storage cost -must be done carefully to avoid disappointing customers -this is usually done already???

Question 51

source of finance: owners' savings

Answer 51

The owner funneling their own money into the business. (internal) +available quickly +no interest - savings too low -increased risk of owner

Question 52

source of finance: issue of shares

Answer 52

``` Issuing shares (external) (long term finance) +permanent source that doesn't have to be repaid +no interest -Dividends are expected -ownership could change -only available to limited companies ```

Question 53

source of finance: bank loans

Answer 53

A sum of money obtained from the bank (external) +quick +varying length of time +large companies given low interest rates -Must be paid back with interest -security or collateral usually required

Question 54

source of finance: selling debentures

Answer 54

long term loan certificates issued by limited companies (external) (long term finance) +very long term (eg 25 years) -must be repaid with interest

Question 55

source of finance: factoring of debt

Answer 55

A debt factor is a special agency that 'buy' the claims on debtors for immediate cash. eg a business is owed $100 but needs the money now. A debt factor gives the business $90 but in return receives 10 installments of $10 from debtor. (external) (short term finance) +immediate cash +reduce risk of collecting debt -doesn't receive 100% value of debts

Question 56

Source of finance: Grants/ subsidies

Answer 56

Capital from outside agencies eg the government (external) +don't have to be repaid -often have 'strings attached' eg the firm must locate in a certain area

Question 57

source of finance: micro-finance

Answer 57

Providing small loans to poor people to set up enterprises in developing countries (commercial banks often avoid this because the profit is so small and customers cannot offer a collateral) (external)

Question 58

Internal finance

Answer 58

Finance obtained from within the business itself | Retained profit, sale of existing assets, sale of inventory, owners' savings

Question 59

External finance

Answer 59

Finance obtained from sources outside of an separate from the business (Bank loans, selling debentures, factoring of debts, grants, microfinance)

Question 60

Short term finance

Answer 60

provides working capital needed by the businesses for day-to-day expenses (Overdrafts, trade credit, factoring of debts)

Question 61

Long term finance

Answer 61

finance available for more than a year (bank loans, hire purchase, leasing, issue of shares, long term loans, debetures)

Question 62

source of finance: overdrafts

Answer 62

When a bank allows a firm to withdraw more finance than they own on the condition that it is paid back (external) (short term finance) +flexible +interest only paid on amount overdrawn +sometimes cheaper than loans in the short term -interest rate vary, can be very high -bank can ask for overdraft to be repaid on a short notice

Question 63

Source of finance: trade credit

Answer 63

when a business delays paying its suppliers, which gives the business more working capital (short term finance) +basically an interest free loan (hallelujah!) -based on trust, if not paid, then supplier may stop offering discounts or stop supplying altogether

Question 64

source of finance: hire purchase

Answer 64

Allows a business to buy a fixed asset over a long period of time with monthly payments and interest (long term finance) +no large cash sum required -cash deposit required -interest may be high

Question 65

source of finance: leasing

Answer 65

allows a firm to use an asset without purchasing it for a regular payment (long term finance) +no large cash sum required +maintenance carried out by company -total cost of leasing is higher than purchasing the asset Occasionally businesses will sell their fixed assets to a leasing company and lease them. This is called sale-and-leaseback. (ikr so creative))

Question 66

How do businesses choose which source of finance to use?

Answer 66

Purpose and time period (long vs. short term, fixed vs. current asset); amount needed; legal form and size (big companies generally won't use owners' savings and sole traders probably won't bother applying for grants); control (selling shares); risk and gearing (loan capital will raise the gearing)

Question 67

How can a business owner convince a bank to lend?

Answer 67

A cash flow forecast; an income statement; details of existing loans; a collateral; a business plan

Question 68

What convinces shareholders to invest in a business?

Answer 68

An increasing share price; high dividends; a good reputation/ plans for future growth; evidence that other businesses are not good to invest in.