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Business HL > Unit 3 (Finance) > Flashcards

Unit 3 (Finance) Flashcards

1
Q

What is the role of finance?

A

All businesses need money to finance activities. Need to spend money on capital expenditure and revenue expenditure.

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2
Q

What is capital expenditure?

A

Finance spent on non current assets used to generate sales revenue.

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3
Q

What is revenue expenditure?

A

Finance spent on the daily operations of the business.

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4
Q

What are owner’s savings?

A

Key sources of funds when business starts up, owners may introduce savings for business finances. Owners invest as business grows as it requires specific needs for businesses.

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5
Q

What are retained profits?

A

Profit generated in previous years not used for dividends and reinvested back into business. Used as cheap source of finance with no borrowing or interest fees. However, opportunity costs of investing money back into business as shareholders do not receive extra dividends as well as not having large capital.

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6
Q

What are sales of assets?

A

Selling business assets no longer required to generate finance, sale / leaseback arrangement used if business wants to continue using asset but needs cash.

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7
Q

What are adv of internal sources of finance?

A

Often free and arranged quickly and doesn’t involve 3rd parties who influence business decisions?

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8
Q

Dis of sources of finance

A

Significant opportunity cost once used, not available for other purposes. May not be significant to meet business’s needs.

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9
Q

What is share capital?

A

Finance raised from sales of shares in limited company through issues of shares usually entitled to share or profits when dividends declared. Also have wrote to vote in composition of BOD’s.

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10
Q

What are loans?

A

Likely available for larger businesses and repaid over 5-20 years, interest rates vary over amount of loan and can be negotiated. Failure to pay often means non current assets need to be sold and loans paid back by cash.

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11
Q

What are overdrafts?

A

Arrangement between business and bank to spend over money that has in account, limited usage and interest charge when business overdrawn. Often short term form that offers flexibility to fix cash flow issues.

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12
Q

What are trade credits?

A

Agreement between suppliers for raw materials to be paid back at later date, usually short term that is interest free and used by larger businesses.

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13
Q

What is leasing?

A

Assets made available to business in return payments, business doesn’t own business during lease periods so not responsible for maintenance and also more expensive in long term rather than buying straight up.

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14
Q

What is crowdfunding?

A

Allows business to provide large number of small investors on online platforms. Businesses need to provide persuasive business plan to convince individuals to invest in products due to heavy competition. Usually attracted by incentives like samples, discounts, memberships, early assess and shares.

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15
Q

What is micro finance?

A

Small lenders make finance directly available to businesses unable to assess finance elsewhere. Few formalities in applying for finance but amount often limited.

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16
Q

What are business angels?

A

Some businesses specialise in making investment in expanding businesses and tends to be more risk taking than banks. However relies on knowing right people so networking vital to secure deals with business angels. Angels can stake in business and directly involved in decision making and receives shares of business profits.

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17
Q

What is business expenditure?

A

Businesses need to spend money to earn money, referred to costs and the expenditure in producing good or service

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18
Q

What are fixed costs?

A

Costs that the business must pay regardless of how much it produces or sells. Must be paid even if no output.

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19
Q

What is variable costs?

A

Cost of production that changes in proportion to level of output. If output is zero then total variable costs are also zero.

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20
Q

What is total costs?

A

Total amount of costs found through the total variable costs plus the total fixed costs.

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21
Q

What are direct costs?

A

Costs that are specifically related to individual project or output of particular good or service, typically is also variable costs

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22
Q

What are overhead costs?

A

Costs that cannot be traced to production or sale of any single product, typically fixed costs however overheads difficult to identify with business activity

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23
Q

What is total revenue?

A

Money coming into the business from selling goods or services, known as sales revenue.

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24
Q

Fórmula for total revenue?

A

Price x Quantity

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25
Q

What are revenue streams?

A

Money received into the firm other than the sales revenue:
Example:
Advertising
Transportation fees
Sponsorships
Merchandise
Franchise Sales

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26
Q

What is contribution?

A

Refers to sum of money that remains after variable and direct costs have been taken away from sales revenue?

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27
Q

What is contribution unit formula?

A

Selling price - variable cost per unit

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28
Q

What is Break even point formula

A

Fixed costs / Selling price - variable cost per unit

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29
Q

What is unit contribution?

A

Proportion of selling price per each unit of output that goes towards paying of the fixed costs

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30
Q

What is total contribution?

A

Refers to quantity of output needed towards paying off total fixed costs

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31
Q

What is total contribution formula?

A

Unit contribution x output

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32
Q

What are purposes of break even analysis?

A
  • Pricing strategies
  • Prioritise products in portfolio
  • Decide on whether to make or buy in products
  • Make special order decisions
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33
Q

What is break even analysis?

A

Exists when a firm makes neither a profit or loss. Helps to determine the level of sales that must be generated for firm to earn a profit.

34
Q

Benefits of break even analysis?

A
  • Identify whether product financially worth to produce
  • Determine how much profit can be generated if business idea goes to plan
35
Q

What is margin of safety formula?

A

Actual sales / Forecast sales - BEP

36
Q

What are 3 pieces of info businesses need for sales forecasting?

A

Just knowing BEP not enough when deciding whether to sell a product, needs to know:
- How much profit they might make
- How much unit of output needed to produce
- How much to charge for selling price

37
Q

What is total profit quantity formula?

A

Fixed costs + Target profit / Price - Variable cost

38
Q

What are assumptions of break even point?

A

Costs are linear
Sales revenue is linear
Assumes all output will be sold

39
Q

What are limitations of break even?

A

Not useful to dynamic business environment due to static nature
Bad data will lead to bad information
Ignores quantitative / qualitative factors
Only suitable for single product firms.

40
Q

What are final accounts?

A

Comprises of profit and loss acounts and balance sheets as business needs to keep records of financial statements. Also a legal requiremetn

41
Q

Why are stakeholders interested in final accounts?

A

Legally obliged to produce final accounts which can ensure transparency in use of company funds when reporting to stakeholders

42
Q

What are profit and loss accounts?

A

Shows net profit or loss of a business over a trading period, usually a year

43
Q

Difference between profit and surplus?

A

Profit after expenses taken away, distributed to rewards stakeholders through dividends or retained profits. Surplus is profit business earns after expenses paid for but non profit interest so all profit goes back into business operations

44
Q

What are methods to improve gross profit or surplus?

A
  • Increase sales revenue )Increase selling price or sell greater quantity by marketing strategies)
  • Reducing cost of sales (Use cheaper supiliers, buy in bulk discount)
  • Increase funcing (Seek corporate sponsors / funding strategies) - only for non profit
45
Q

What are methods of improving net profit or surplus?

A
  • Reduce rent through cheaper location
  • Install effecient machinery
  • find cost effective suppliers
  • reducing marketing costs
  • reduce salaries
  • Seek volunteers for reduced labour costs (only for non profit)
46
Q

What are balance sheets?

A

Value of a firm at one point in time, usually last day of the financial year. Legally required by firms for auditing purposes.

47
Q

What are assets?

A

Items of monetary value owned by a business

48
Q

What are liabilities?

A

Legal obligations of the busines to repay lenders or suppliers at a later date.

49
Q

What is equity?

A

Shows the value of the business through share capital or retained earnings

50
Q

What are intangible assets?

A

Non physical fixed assets that can earn revenue for a business, can account for large porportion of firms asset value although difficult to place objection and account prices on such assets.
EX:
- Brand
- Patents
- Copy rights
- Goodwill reputation
- Registered trademarks or slogan

51
Q

What is depreciation?

A

Non current assets tend to lose value over time which is known as depreciation. Can be because of wear and tear or advance in technology or newer versions of products.

52
Q

What are methods of depreciation?

A

Spreading purchase cost of non current asset over life time:
- Straight line method
- Units of production method

53
Q

What is lifespan?

A

USeful life of a non current asset

54
Q

What is residual value?

A

Estimation of value at end of the linespan

55
Q

Accumulated depreciation?

A

Annual depreciation expense multiplied by the number of years asset will be used for

56
Q

What is net book value?

A

Original purchase cost of an asset.

57
Q

Formula for straight line method?

A

Purchase cost - Residual value / Lifespan

58
Q

ADV / DIS of straight line method?

A

ADV: Simple to calculate / understand
DIS: Depreciating same amount each year not realistic as some asssets lose a much larger percentage of value at beggining of useful life.

59
Q

Formula for units of production method?

A

Purchase cost - residual value / Expected no. of units over lifetime

60
Q

ADV / DIS of units of production?

A

ADV: Better insights into the true running costs of a non current asset
DIS: Harder to calculate compared to straight line

61
Q

What is gross profit margin formula and explanation?

A

Formula: Gross profit / Sales revenue * 100

Shows value of gross profit as percentage of sales revenue. Analyses profitability of firm after deducting direct costs. Higher the better as more profits twoards paying off expenses

62
Q

Strategies to increase GPM?

A

Raise revenue:
- Increase selling price if inlastic
- Decrease selling price if elastic
- Produce products with higher GPM

Reduce costs of sales:
- Reduce direct costs by seeking alternative suppliers
- Reduce direct labour costs

63
Q

What is net profit margin formula and explanation?

A

Formula = Profit before tax/interest / Sales revenue * 100

Shows value of net profit as percentage of sales revenue. Analyses profitablity of firm after deducting indirect costs from gross profit.
Uses profit before tax/interset as interest / tax rates change so harder to benchmark agaisnt previous or future years.
HIgher the NPM the better, morf profits twoards dividents / retained profits

64
Q

What is return on capital employed and its formula?

A

Profit before interest / tax / Capital employed * 100.
Capital employed = non current liabilities + equity

Profitability ratio that analyses financial performance with amount of capital invested
Higher the better, can see how efficiently invested money turns into profit

65
Q

Strategies to improve ROCE?

A
  • Reduce indirect costs
  • Seek cheaper rental premise
  • More effecient machinery / equipment
  • Altenrative cheaper suppliers
  • Cheaper forms of marketing
66
Q

What are liquidity ratios?

A

Abililty of firm to back back short term liabilities. Important as they reveal level of working capital which firms can meet everyday obligations

67
Q

What is current ratios formula and explanation?

A

Formula = Current assets / current liabilities

Deals with liequid assets and short term liabities of firm working capital
Helps reveal wehtehr firm can use liquid assets to cover for short term debts

68
Q

How to interpret current ratios?

A

Ideal benchmark is 1.5:1 or 2:1, this means for every $1 of current liabilties, firm has 1.5 to 2 of current assets to pay for it
Over 1 = liquidable, higher the better but if too high business too conservative so holding too much cash thus having opportunty cost

69
Q

What is the ACID test ratio formula and explanation?

A

Formula = Current asset - stock / current liabilties

Current ratio exepct ignores stock when measuirng short term liquid of busienss
Ideal benchmark is 1:1, this means for every 1$ of current assets, firm has 1$ of cash or debtors to pay for it

70
Q

Strategies to improve liquidity ratios?

A

Raise value of current assets
- Encourage cahs payments by offering discounts
- Invest in stock control system to reduce amount of stock held

Reduce value of current liabilities
- Cut overdraft and use more long term loans with lower interest rates
- Avoid late payments from creditors
- Use Tran specialist to reduce tax liabilities

71
Q

What are effeciency ratios?

A

How effecient at business managing its resources. Calcualtes vlaue of business liabitiles and debst against its equity

72
Q

What is stock turnover and formula?

A

Number of times firm sells its stock within a time period, usuall 1 year. Indicates speed at which firm sells or replenishes stock.
Formula (no. of times) = Cost of sales / average stock (Higher the better)
Formula (no. of days) = Average stock / cost of sales (lower the better)

73
Q

How to interpret stock turnover?

A

Important to compare with similar businesses
Differnet business will have different benchmark figure for stock turnover
Low or high not necessarily good or bad, depends on the business
Faster the stock turnover better for firm as sooner the stock can be replenished and selling can resume to earn sales revenue

74
Q

Strategies to improve stock turnover?

A

Hold lower stock levels, requires more inventory to replenish more regularly
Divestemnt of stocks that are unpopular or slow to sell
Reduce range of products being selected by only having best selling products

75
Q

What is debtors days formula and explanation?

A

Formula = Debtors / sales revenue * 100
measures average no. of days that it tkaes business to collect money from debtors

76
Q

How to interpret debtor days?

A

Generally lower the better, can improve cash flow if consumers pay on time
If ratio too long can cause liquidity problems
if ratio too short can cause custoemr to seek other suppliers with better trade credit
Healthy benchmark uusally 30 to 60 days but depends on type of business

77
Q

Strategies to improve debtor days?

A

Impose charge on later payers
Give debtors incentive to pay earlier like discounts
Refuse business with client unless payment is made
Threaten legal action

78
Q

What is creditor days formula and explanation?

A

Creditors / cost of sales * 365
Used to meausre no. of days it takes on average for busine/ss to pay its trade creditors
Lower the better, more effecient at paying back creditors thus better cash flow

79
Q

How to interpret creditor days?

A

Higher the better as repayments prologned so frees up cash elsewhere. however, lower also better as firms can void penalties and build strong relationship with trade creditors
Uusally 30 to 60 days

80
Q
A

Business HL (15 decks)

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