Unit 5: Finance and accounting Flashcards

Question

Short term external source of finance: Overdraft (definition + advantage + disadvantage)

Answer 1

A short-term loan from a bank that allows a business to withdraw more money than it has in its account, up to a set limit. Advantages: - Flexible—can be used when needed. - Quick access to extra funds for short-term needs. Disadvantages: - High interest rates make it expensive. - The bank can ask for repayment at any time.

Answer 2

When a business buys goods or services from a supplier but pays for them later, usually after 30, 60, or 90 days. Advantages - Helps cash flow by delaying payments. - No interest if paid within the agreed period. Disadvantages: - Late payment can lead to penalties or loss of discounts. - Suppliers may refuse future credit if payments are delayed.

Answer 3

When a business sells its unpaid customer invoices to a factoring company for immediate cash, but at a reduced value. Advantages: - Provides quick cash to improve cash flow. - Reduces the risk of bad debts (unpaid invoices). Disadvantages: - The business receives less money than the full invoice value. - Customers may lose trust if they have to deal with a third party.

Answer 4

- Hire purchase & leasing - Bank loan - Debentures - Share capital - Business mortgages - Government grants - Venture capital

Answer 5

A company purchases an asset and agrees to pay fixed repayments over an agreed time period. The asset belongs to the purchasing company once the final repayment has been made.

Answer 6

Renting an asset for a set period instead of buying it. The business makes regular payments but never owns the asset. The asset is owned by the leasing company.

Answer 7

Loans that do not have to be repaid for at least one year.

Answer 8

Long-term bonds issued by companies to raise debt finance, often with a fixed rate of interest.

Answer 9

Permanent finance raised by companies through the sale of shares.

Answer 10

Long-term loans to companies purchasing a property for business premises, with the property acting as collateral security on the loan.

Answer 11

Risk capital invested in business start-ups, or expanding small businesses that have good profit potential but do not find it easy to gain finance from other sources.

Answer 12

Advantages: - Spreads the cost over time, making expensive assets more affordable. -The asset can be used immediately without full payment upfront. Disadvantages: - Total cost is higher due to interest charges. -The business does not own the asset until the final payment is made.

Answer 13

Advantages: - Lower upfront costs compared to buying. - Maintenance and repairs are often covered by the leasing company. Disadvantages: - The business never owns the asset. - Long-term leasing can be more expensive than buying outright.

Answer 14

Advantages: - Allows businesses to borrow large amounts for long-term growth. - Fixed repayment schedule helps with financial planning. Disadvantages: - Interest must be paid, increasing overall cost. - The bank may require collateral (e.g., property) as security.

Answer 15

Advantages: Fixed interest rates make repayment predictable. Can raise large amounts of money for long-term projects. Disadvantages: - Interest must be paid even if the business is not making a profit. - Increases the company’s debt burden, which may affect future borrowing.

Answer 16

A long-term loan used to buy property or land, with the property serving as security for the loan. Advantages: - Allows businesses to buy property without paying the full amount upfront. - Fixed or variable repayment plans help with budgeting. Disadvantages: - Interest increases the total repayment cost. - The property can be repossessed if repayments are not made.

Answer 17

Money raised by a business through the sale of shares to investors, giving them ownership in the company. Advantages: - No need to repay the money or pay interest. - Investors may bring additional expertise or connections to the business. Disadvantages: - Dilutes ownership and control of the business. - Profits must be shared with shareholders as dividends.

Answer 18

- Obtain a listing on the Alternative Investment Market. Concerned w/ smaller companies that aim to raise limited amounts of additional capital. - Apply for a full listing on the Stock exchange. Done in 2 ways: - Public issue by prospectus - Advertises the company & its share sale price to the public. Is expensive. - Rights issue of shares to existing shareholders - With rights issue, the ownership doesn't change and the company raises capital cheaply. However, rights issue increases supply of shares to stock exchange.

Answer 19

An asset which a business pledges to a lender and which must be sold off to pay a debt if the loan is not repaid.

Answer 20

Existing shareholders are given the right to buy additional shares at a discounted price.

Answer 21

Investment provided by firms or individuals to startups or small businesses with high growth potential, usually in exchange for equity. Advantages: - Provides significant funding for growth and expansion. - Investors often provide valuable expertise and networking opportunities. Disadvantages: - Involves giving up a portion of ownership and control. - Venture capitalists may expect a quick return on investment, adding pressure to grow quickly.

Answer 22

LOANS - No shares are sold so ownership of company doesn't change and isn't diluted by issue of additional shares. - Loans will be repaid therefore there is no increase in liabilities for business. - Interest changes are an expense of the business and are paid out before corporation tax is deducted. However: dividends from shares HAVE to be paid. - The lvl of indebtedness of the company increases and this gives shareholders the chance of higher returns in future. SHARE CAPITAL - Never has to be repaid as its permanent capital. - Dividends don't have to be paid every year. Directors can decide to retain more earnings by reducing dividend payments. - It lowers the indebtedness of the business, do debt finance becomes a lower proportion of long-term finance.

Answer 23

- Bank overdrafts + bank loan - Microfinance - Crowd funding - Credit from suppliers (trade payables) - Loans from family and friends - Owners' investment - Taking on partners w/ capital to invest.

Answer 24

- Unincorporated businesses cannot raise finance from sale of shares and likely to be unsuccessful in selling debentures as they are usually unknown firms. - Lenders are reluctant to offer loans/overdrafts unless the owners give personal savings. - Owners may have insufficient savings. - Family & friends may lend finance. However: its difficult to charge interest and can insist upon repayment at any time. - Government grants.

Answer 25

Providing financial services for poor and low-income customers who do not have access to banking services.

Answer 26

Advantages: - Helps small businesses and entrepreneurs start or expand. - No need for collateral, making it accessible to more people. Disadvantages: - Interest rates can be high. - Loan amounts are usually small, limiting business growth.

Answer 27

The use of small amounts of capital from a large number of individuals to finance a new business venture.

Answer 28

Advantages: - Can raise funds without taking on debt. - Creates public interest and support for the business. Can be used to promote the business effectively. - Raise good sums of capital from a large no. of ppl. Disadvantages: - No guarantee that enough money will be raised. - Requires strong marketing to attract investors. - Must keep accurate records of the thousands of investors to pay back interest/capital/share of profits.

Answer 29

The sum of cash payments to a business less the sum of cash payments from the business.

Answer 30

When a business cannot meet its short-term debts.

Answer 31

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

Answer 32

- New business start-ups offered shorter credit to pay suppliers than larger, well established firms. - Banks/lenders need to see evidence of a cash flow forecast before making finance available. - Accurate planning is more significant for business start-ups.

Answer 33

Cash payments into a business. - Owner's capital injection. - Bank loan payments. - Cash sales from customers. - Trade receivables payments.

Answer 34

Cash payments out of a business. - Lease payment for premises. - Annual rent payment. - Electricity, gas, water and telephone bills. - Wages. - Cost of materials & payments to suppliers.

Answer 35

Difference between cash inflows and cash outflows for the period.

Answer 36

Cash held by the business at the start of the month.

Answer 37

Cash held by the business at the end of the month, which becomes the next month's opening balance.

Answer 38

Opening cash balance + (cash inflows - cash outflows)

Answer 39

- They show negative closing cash flows, meaning that plans can be made to source additional finance (overdraft/injection of capital). - They indicate periods of time when negative net cash flows are excessive. The business can reduce these by taking measures to improve cash flow. - They are essential to all business plans. A business start-up will never gain finance unless investors/bankers have access to a cash flow forecast & the assumptions behind it.

Answer 40

- Mistakes can be made in preparing the revenue and cost forecasts/they may be drawn up by inexperienced entrepreneurs or staff. - Unexpected cost increases lead to inaccuracies in forecasts. - Incorrect assumptions can be made in estimating the sales of the business (poor market sale research?). This makes cash flow forecasts inaccurate.

Answer 41

1- Lack of planning - Financial planning is needed to predict cash flow problems so managers can know how to overcome with a lot of time. 2- Poor credit control - If credit control is badly managed, trade receivables will not be chased for payment and bad debts will be identified. 3- Allowing customers too long to pay debts - trade credit is needed to be offered by businesses to remain competitive, a customer choosing trade credit can improve cash inflow (not too long tho!) 4- Expanding too rapidly - needed to pay for expansion/wages/material before it receives cash from more sales. Overtrading leads to cash flow shortages. 5- Unexpected events - Leads to (-) net cash flow. Could make cash flow forecast inaccurate.

Answer 42

Monitoring of debts to ensure that credit periods are not exceeded.

Answer 43

Unpaid customer's bills that are now very unlikely to be repaid.

Answer 44

Expanding a business rapidly w/ obtaining all necessary finance, resulting in cash flow shortage.

Answer 45

- Increase cash inflows. - Reduce cash outflows.

Answer 46

- Overdraft Drawbacks: Interest rates are high & may be an arrangement fee. Overdrafts can be withdrawn by the bank, which causes insolvency. - Short-term loan Drawbacks: Interest costs & loans have to be repaid by due date. - Sale of assets - cash receipts can be obtained from selling off redundant assets, which boosts cash inflow. Drawbacks: Selling assets quickly results in low prices. The assets might be required at a later date for expansion/used as collateral for future loans. - Sale and leaseback - Assets can be sold but they have to be leased back to owner. Drawbacks: Leasing costs add to annual overheads. Loss of potential profit if assets rise in price. Assets could be used as collateral for future loans.

Answer 47

- Not extending credit to customers or asking customers to pay more quickly. Evaluation: Many customers expect credit, may go elsewhere if not offered. Makes business less competitive. - Selling claims on trade receivables to specialist financial institutions called debt factors - businesses will buy debts from other concerns who need cash. Evaluation: Costly, debtors don't pay 100% of value. - Offering a discount to customers who pay promptly. Evaluation: Cash is paid quickly/discounts reduce profit margins.

Answer 48

- Purchasing more supplies on credit and not on cash. Evaluation: Discounts from suppliers for quick cash payment stopped/won't offer credit terms. - Extend the period of time taken to pay (easier for larger firms). Evaluation: Slow payment by larger businesses is a burden for small businesses to supply them/Suppliers reluctant to supply products or good service if business is a late payer.

Answer 49

- Delay capital expenditure - not buying equipment/vehicles, cash not paid by suppliers. Drawbacks: Efficiency falls if inefficient equipment isn't replaced. Expansion becomes difficult. - Use leasing of capital equipment - leasing company owns the asset and no large cash outlay is required. Drawbacks: Asset not owned by the business. Leasing charges include interest cost + add to annual overheads. - Cut overhead costs that do not affect output. Drawbacks: Future demand may be reduced by failing to promote products effectively.

Answer 50

The level of output at which total costs equal total revenue, when neither profit or loss is made.

Answer 51

- Calculation of profit/loss. - Pricing decisions. - Measuring performance. - Setting budgets. - Resource use.

Answer 52

The section of a business, such as a department or a product, that incurs the costs.

Answer 53

These costs can be clearly identified with each unit of production and can be allocated to a cost centre.

Answer 54

Costs that cannot be identified with a unit of production or allocated accurately to a cost centre.

Answer 55

Costs that do not vary with the level of output in the short-run, for example, the rent of a factory or shop.

Answer 56

Costs that vary with output. for example, the direct cost of materials used in making a washing machine or the electricity used to cook a fast-food meal.

Answer 57

Variable cost + fixed cost

Answer 58

- Labour costs are often variable & direct costs. They become fixed costs, however, when labour is unoccupied due to lack of orders. Becomes an overhead cost. - Salaries of administration, selling, and non-productive employees are indirect costs. They do not vary w/ output and are fixed. - Example: Electricity costs in a busy factory is directly allocated to each product made.

Answer 59

- In a manufacturing business: products, departments, factories, stages of production. - In a hotel: restaurant, reception, bar, room letting and conference section. - School: different subject departments.

Answer 60

- Each branch of chain of shop. - Each department of a production store. - In multi-product firm, each product is overall portfolio of the business.

Answer 61

A section of a business to which both costs and revenues can be allocated, so profit can be calculated.

Answer 62

- Managers & employees have targets to work towards. - These targets can be used to compare with actual performance and help identify areas that are/aren't performing well. - Individual performances of divisions & their managers can be assessed and compared. - Work can be monitored and decisions made about the future. For example: should profit centre be open or price of product to increase?

Answer 63

- Production overheads - factory rent & rates, depreciation of equipment/power. - Selling & distribution overheads - including warehouse, packing and distribution costs, and salaries of sales employees. - Administration overheads - office rent & rates, clerical and executive salaries. - Finance overheads - interest rate on loans.

Answer 64

Total cost divided by the no. of units produced.

Answer 65

A method of costing in which all indirect and direct costs are allocated to the products, services or divisions of a business.

Answer 66

- Identify and add up all indirect costs. - Calculate total overheads of the business for a given time period. - Add total direct costs of making the product. - Calculate average cost of producing each product by dividing total costs by output.

Answer 67

- More relevant for single-product businesses. No uncertainty abt share of overheads to be allocated to the product. - All costs are allocated so no costs are left out of the calculation of total full cost or unit full cost. - Full-costing is good for pricing decisions in single-product firms. If full unit cost is calculated, this is cost plus pricing. - Full costing data can be compared from one time period to another to assess performance.

Answer 68

- No attempt to allocate each overhead cost to cost centres or profit centres on basis of actual expenditure incurred. - Inappropriate methods of overhead allocation can lead to inconsistencies between departments and products. - Risky to use this cost method for making decisions. Figures may be misleading.

Answer 69

Costing method that allocates only direct costs to cost centres and profit centres, not overhead costs.

Answer 70

The additional cost of producing one more unit of output.

Answer 71

- Existing customers may realize lower prices are being offered to new customers and demand a similar price. Could lead to a loss. - If high prices were key in establishing exclusivity in a brand, offering lower prices ruins the hard-won image. - When there is no excess capacity, sales at a price based on contribution cost could reduce sales based on full cost price.

Answer 72

- Can be used in setting prices that cover direct costs of production. - In decision-making over whether to close a cost/profit centre as they are made on the basis of contribution to indirect costs. - Excess capacity can be effectively used if special orders/contracts make a positive contribution are accepted. Can be used in decision-making on special order decisions.

Answer 73

- When making decisions abt business expansion or developing new products. - Contribution costing doesn't take into account how some products result in higher indirect costs than others. Not suitable for single-product firms, as they have to cover fixed costs w/ revenue from the single-product. - May lead managers to choose to maintain production of goods bc of positive contribution, however a brand-new product can be launched that can make an even greater contribution. - Qualitative factors should be considered.

Answer 74

Uses cost and revenue data to determine the break-even point of production.

Answer 75

The amount by which the current output level exceeds the break-even level of output.

Answer 76

The price of a product less the direct (variable) costs of producing it.

Answer 77

- Charts are easy to construct & interpret. - Analysis provides useful guidelines to management on break-even points, safety margins and profit/loss lvls at dif rates of output. - Comparisons can be made between different options by constructing new charts to show changed circumstances. - Break-even analysis can be used to assist managers in important decision making (location decisions, whether to but new equipment & which project to invest in).

Answer 78

- Costs and revenues aren't always linear. Some variable costs do not change directly with output. - The revenue line may be influenced by price reductions needed to sell a higher level of output, could lead to 2 BE points. - Not all costs can be classified into fixed/variable (esp semi-variable costs). - BE chart makes no allowance for inventory lvls. Assumes all units produced are sold (usually unlikely). - For new businesses, BE charts are based on forecasts (inaccurate).

Answer 79

Planning future activities by establishing performance targets, especially financial ones.

Answer 80

- No direction/purpose. - Unable to allocate scarce resources effectively. - Have demotivated employees with no plans/targets to work towards. - Unable to measure its progress by measuring the plans against performance.

Answer 81

- Planning - Budgeting process needs to be considered by managers carefully so realistic targets are set. - Allocating resources - Effective way of making sure the business doesn't have to spend more than it has to. - Setting targets - This motivation can increase if the budget holder/profit centre manager delegated accountability of reaching budget lvls. - Coordination - Controlling & monitoring a business - Checks should be undertaken to regularly control/monitor performance of budget holder & department. - Measuring & assessing performance - As budget period ends, variance analysis is used to compare actual performance w/ original budgets.

Answer 82

The individual responsible for the initial setting and achievement of a budget.

Answer 83

Calculation of the differences between budgets and actual figures, and analysis of the reasons for such differences.

Answer 84

- Lack of flexibility - Unexpected changes in the external environment makes them unrealistic. This demotivates the budget holder & other employees. - Focus on the short-term - (for next 12 months): short-term decisions are taken which isn't in the long-term interest of the business. - Unnecessary spending - If managers underspent their budgets before the end of budgeting period, they may spend unnecessarily so the same level of budget can be justified next year. - Training on budgets. - Budgets for new projects - difficult & inaccurate esp if not undertaken before.

Answer 85

- A budget isn't a forecast but a plan to fulfil. - May be established for any part of an organization as long as outcome of operation is measurable. - Coordination between departments when establishing budgets. - Budget setting should involve participation. Decisions abt them should be made with managers who are responsible for meeting targets and those fulfilling a budget are involved in setting it. This sense of ownership helps to motivate the department to reach targets (known as delegated budgets). - Budgets are used to review performance of each manager controlling cost/profit centre. (Managers successful/unsuccessful, appraised, etc).

Answer 86

Budgets which junior managers have been given some authority for setting and achieving.

Answer 87

Uses last year's budget as a basis, and an adjustment is made for the coming year.

Answer 88

Sets budgets to zero each year and budget holders have to argue their case for target levels and to receive finance.

Answer 89

Advantages: - Adds incentive to managers to defend the work of their own section. - Changing situations can be reflected in dif budget levels every year. Disadvantages: - Time-consuming due to review of work & importance of each budget-holding section needed each year.

Answer 90

Cost budgets for each expense are allowed to vary if sales or output vary from budgeted levels.

Answer 91

A change from the budget that leads to higher than planned profit.

Answer 92

A change from the budget that leads to lower than planned profit.

Answer 93

- More motivating for budget-holding managers as they won't be criticized for adverse variances. - Flexible targets are more realistic. - Flexible budgets make it easier to produce valid & accurate variance analyses as they indicate changes in efficiency, not output.

Answer 94

- Variance is the difference between a budget and the actual figures achieved at the end of the budget period. It is important to calculate these because: - Variances measure differences from planned performance of each department over a given period. - Can help set more realistic budgets in the future. - Helps the business take better decisions. - The performance of each individual cost/profit centre may be appraised in an accurate/objective way.

Answer 95

- Revenue is below budget bc either fewer units were sold/SP had to be lowered due to competition. - Raw materials costs are higher than planned bc either output was higher than budgeted or cost per unit of materials increased. - Labour costs are above budget because wage rates raised due to shortages of workers or labour time taken to complete work took longer than expected. - Overhead costs are higher than budgeted.

Answer 96

- Revenue is above budget due to higher economic growth/competitor closing down. - Raw material costs are are lower because either output was below budget or unit cost of materials was below budget. - Labour costs are below budget because of either lower wage rates or quicker completion of work. - Overhead costs are lower than budgeted.

Answer 97

- Identifying potential problems early so that remedial action can be taken. - Allowing managers to concentrate their time & efforts on major problem areas, known as management by exception.

Unit 5: Finance and accounting Flashcards

(121 cards)