Y11 HL BUSINESS FINANACE

Question 1

Why do businesses need finance?

To start-up a business

Answer 1

Money to set-up a business. Used to buy equipment, market research, legal fees, refurbish premises.

Question 2

Short-term needs

Answer 2

Money to fund the day to day running of the business when revenue isn’t sufficient to cover all the expenses. This may be because trade is seasonal, the business is waiting payment from a customer or there has been an emergency. Used to buy raw materials, stock, pay bills. The money borrowed is repaid within a year.

Question 3

Long-term needs

Answer 3

The money borrowed takes longer than a year to repay. The owners can provide long-term finance and this is called capital. Long-term loans can also be obtained from banks. Long-term finance may be used to buy equipment and premises.

Question 4

Expansion

Answer 4

Money is required to grow which can include increasing output, developing new products, entering overseas markets

Question 5

Internal sources of finance

Answer 5

Comes from inside the business

• retained profit
• personal savings
• sale of assets

Question 6

External sources of finance

Answer 6

Comes from outside the business

• bank loan
• overdraft
• trade payables
• share capital
• stock market flotation for PLCS
• venture capital
• crowdfunding

Question 7

Internal sources of finance

Personal Savings

Answer 7

This is the money put into a business by its owner or owners, depending. The money could come from the owner’s savings or redundancy payments. It is particularly applicable for sole traders and partnerships because they cannot sell shares to raise finance. An advantage of personal savings is that there are no interest charges. However, on the other hand, the entrepreneurs may not have enough money to start the business and may also need to use other sources of finance

Question 8

Internal sources of finance

Retained Profits

Answer 8

A successful business will make a profit. Businesses can choose to save some of this profit and this is known as retained profit. This money can then be used for various purposes such as paying off debts or expanding the business (developing new products, opening new shops).

Question 9

Internal sources of finance

Retained profits advantages

Answer 9

Advantages

• The business does not incur any costs, such as paying interest on a bank loan.
• It is quick to obtain.
• Retained profit can earn interest in the bank

Question 10

Internal sources of finance

Retained profits disadvantages

Answer 10

Disadvantages

• Once the money is used, the business may not have any spare cash to cover unforeseen circumstances.
• It is only available to successful businesses.
• Shareholders may be unhappy if the money is not given to them as a dividend.

Question 11

Internal sources of finance

Sale of Assets

Answer 11

Existing businesses may have equipment, land or property that they no longer require which they can sell to raise finance. Sometimes the asset being sold may be part of the business.

Question 12

Internal sources of finance

Sale of Assets advantages

Answer 12

Advantages

• Does not incur interest charges
• Assets such as equipment can be sold then leased back. The business has then raised cash but still has use of the asset.

Question 13

Internal sources of finance

Sale of Assets disadvantages

Answer 13

Disadvantages

• The business may not have assets of any value to sell
• If the business sells an asset such as a machine, this may lower a businesses’ capacity and how much it can produce. They may require it again at a later date, for example because customer demand increases. They may then have to re-purchase the asset.

Question 14

External Sources of Finance

Short-term: Overdraft.

Answer 14

An overdraft is where a bank allows a business (or an individual) to spend more money than there is in the account, up to an agreed limit. With an overdraft a business only borrows what it needs, when it is needed meaning they are very flexible. This reduces the amount of interest to be paid. However, a bank does not have to give a business an overdraft and the rate of interest charged on an overdraft can be quite high. Furthermore, a bank can demand that an overdraft is repaid within 24 hours. A business can fail if it is not able to do this

Question 15

External sources of Finance

Short-term: Trade Payables (also called Trade Credit)

Answer 15

This is where a business buys materials and pays for them at a later date. This is an inexpensive way for businesses to raise finance and it keeps cash in the business for longer so it can be used for other purposes e.g. advertising. However, suppliers may offer discounts for prompt payment so a business using trade payables may up paying more for the resources it is buying. If a business takes a long time to pay, supplier relationships may be damaged in the long-term. This could be harmful if the business operates Just-in-Time and good relations are needed to ensure suppliers delivery on-time.

Question 16

External sources of Finance

Short-term: Credit Cards

Answer 16

This is where a business buys goods and pays for them at a later date. If the business pays for the goods after the credit period then interest is charged. Interest charges can be high making credit cards an expensive source of finance. Credit cards can be a quick, convenient and flexible way to pay for things and interest can be avoided if the credit card bill is paid within the credit period.

Question 17

External sources of Finance

Long-term: Bank Loan (Loan Capital)

Answer 17

Bank loans are where a bank agrees to lend a business amount of money for a given period of time and the business makes regular repayments. Regular repayments can help with budgeting. Interest is charged by the bank on the loan and this must be paid on-time or the bank will take action against the business and this could result in the business being taken to court and closed down. Most bank loans are secured loans. This means they are secured against an asset such as property. If the business fails to repay the loan then the bank will take this asset instead of the loan repayment. Unsecured loans are where the bank has no claim on an asset if the loan cannot be repaid. Unsecured loans are more risky for the bank so therefore have higher interest charges compared to secured loans. New businesses may find it hard to get a loan because banks perceive them as risky, as their sales may not be sufficient to pay back the loan.

Question 18

External sources of Finance

Long-term: Hire Purchase (a type of loan)

Answer 18

With hire purchase the business pays for the assets in instalments and once all payments have been made the business owns the asset. It can be an expensive way to obtain an asset and goods can be repossessed if a business falls behind with repayments.

Question 19

External sources of Finance

Long-term: Share Capital

Answer 19

This is the money invested by shareholders. Private and Public limited companies can sell shares to raise finance.

Question 20

External sources of Finance

Long-term: Share Capital advantages

Answer 20

Advantages

• Selling shares can be cheap and easy
• No interest is payable to shareholders, therefore reducing costs
• May be able to raise larger sums of money because more people are contributing
• Public limited companies can sell shares on the stock exchange to raise large sums of money.

Question 21

External sources of Finance

Long-term: Share capital disadvantages

Answer 21

Disadvantages

• As shareholders, they own part of the company and are entitled to a share of any profits the business makes.
• Shareholders are entitled to a say in how the business is run so if the entrepreneur sells too many shares they may lose control of the business.
• The process of selling shares can be costly

Question 22

External sources of Finance

Long-term: Venture Capital

Answer 22

Venture Capitalists can be individuals or businesses and they specialise in giving loans to small and medium sized businesses. Individual venture capitalists are also known as business angels. Venture Capitalists often have a stake in the business to enable them to have some control over decision making and a share of any profits. Venture Capitalists may invest in new or recently started businesses which are more risky and as a result businesses may seek finance from a venture capitalist if they have not been able to obtain finance elsewhere, for example from banks.

Question 23

External sources of Finance

Long-term: Crowdfunding

Answer 23

This is where large numbers of people invest in a business using the internet. Businesses seeking crowdfunding can put details online on crowdfunding websites such as why they need the money, how much is needed and what benefits investors may enjoy if the venture successful. Crowdfunding can be used for community projects as well as business ventures.

Question 24

How does a business decide which source of finance to use?

Business’ Financial Situation

Answer 24

If a business has been profitable in the past it is likely to have retained profits within the business, so this source of finance should be available to successful businesses. Past success should help a business convince a bank to lend it money as it is more likely to be able to repay a loan.

Question 25

How does a business decide which source of finance to use? Cost of finance

Answer 25

Some sources of finance can be more expensive than others and costs can impact profits. For example interest is payable on bank loans but not on share capital. Cost may come in other forms, for example venture capitalists may want a stake in the business and therefore some control over decision-making.

Question 26

How does a business decide which source of finance to use? Level of risk

Answer 26

Loans can be more risky because interest is payable. If the loan is secured on an asset then a bank may repossess this asset if loan repayments are not made.

Question 27

How does a business decide which source of finance to use? Type and size of business

Answer 27

Only companies can sell shares to raise finance. As public limited companies can sell shares to the public on the stock exchange they can sell more shares and therefore raise more money than private limited companies who can only sell shares to family and friends. Also, private limited companies have to gain the consent of all existing shareholders before selling more shares. Sole traders cannot sell shares and so are more restricted in the options of available, for example bank loans and own capital.

Question 28

How does a business decide which source of finance to use? What the money is to be spent on

Answer 28

Long-term sources of finance are more suitable when large sums of money are needed, for example to finance the purchase of new machinery. Short-term finance is used for smaller amounts of money, for example to pay for stock.

Question 29

Businesses need cash to pay suppliers, overheads and employees

Answer 29

There are serious consequences if these groups aren’t paid. Suppliers may refuse to continue to supply a business, telephone or electricity supplies may be cut off and employees may refuse to work.

Question 30

Businesses need cash to prevent business failure

Answer 30

When a business runs out of cash and cannot pay its debts it is said to be insolvent and can result in the business ceasing to trade.

Question 31

At the end of a trading period a firm’s profit will not be the same at the value of the cash in the bank. Two reasons why this might be are:

Answer 31

- A business may sell some products on trade credit. As a result customers may have bought the goods but not yet paid for them. These sales will increase profit but not the cash balance. - If the owners invest more in the business then the cash balance will rise but putting more money in the business has nothing to do with profit.

Question 32

Cash flow?

Answer 32

The flow of money in and out of a business over a period of time

Question 33

Cash inflow?

Answer 33

Money coming into a business, e.g, cash from sales and owner, bank loan

Question 34

Cash outflow?

Answer 34

Money coming out of a business, e.g, wages, advertising, energy bills

Question 35

How businesses monitor their cash flow/what is a cash flow forecast?

Answer 35

A cash flow forecast is a prediction of all expected receipts and expenses of a business over a future time period, which shows the expected cash balance at the end of each month

Question 36

Net cash flow?

Answer 36

Total cash in - total cash out

Question 37

Closing balance?

Answer 37

Net cash flow + opening balance

Question 38

Why do businesses produce cash flow forecasts?

Answer 38

- Helps a business find out if it will be short of cash - Enables a business to take action to prevent the business running out of cash - Cash flow forecasts are useful when applying for bank loans or overdrafts. If a business can show a sustained positive closing balance then the bank will be more confident that about granting a loan or overdraft because it is more likely it will be repaid. - A business can analyse its cash outflows and see how money has been spent. It may help a business identify ways of saving money and reducing costs.

Question 39

What are the consuquences of a business running out of cash?

Answer 39

- If the business does not have any cash, to pay bills, it will no longer be able to trade. The business is termed ‘insolvent’. - A ‘receiver’ is appointed to oversee the business. - The receiver will try to sell and find a buyer for the business - If no one will buy the business, the business will close down; all the assets will be sold. - The money from the sales of the assets will be given to the people the business owes money to.

Question 40

Insolvency?

Answer 40

Inability to meet debts. When a business is not able to meet its financial commitments when they are due. The business has to stop trading by law.

Question 41

Receiver?

Answer 41

A person who takes responsibility for an insolvent business and makes arrangements for the business’s debts to be repaid, for example by selling the business and its assets. The business is said to be ‘in receivership’.

Question 42

Solutions to cash-flow problems Delay payments to suppliers

Answer 42

Delay payments to suppliers to allow time for more money to be received from sales. Suppliers may not be happy and refuse to supply in the future

Question 43

Solutions to cash-flow problems Speed up cash inflows

Answer 43

Persuade customers to pay promptly, but customers may go to competitors who allow them more time to pay.

Question 44

Solutions to cash-flow problems Reduce cash outflows

Answer 44

Employ fewer staff, buy cheaper raw materials or buy stocks in smaller quantities. However, buying cheaper raw materials may be poor quality which results in customers being dissatisfied and lower sales in the future

Question 45

Solutions to cash-flow problems Bank overdraft

Answer 45

A short-term, flexible bank loan, that can be obtained quickly but higher rates of interest are charged

Question 46

Solutions to cash-flow problems Owners invest more money in the business

Answer 46

No interest is charged, but do the owners have the money available?

Question 47

Solutions to cash-flow problems Advertising

Answer 47

Could help to increase sales by attracting more customer, but adverts will cost the business money, increasing cash outflows.

Question 48

Price?

Answer 48

This is the amount a business asks a customer to pay for a single product. When deciding on how much to sell a product for an entrepreneur will need to consider: • How much competitors sell their products or services for • How much it costs to make the product or provide the service

Question 49

Sales?

Answer 49

This is the number of products sold by a business over a given time period, e.g. month or year. It is stated in terms of the number of product sold and NOT in terms of money.

Question 50

Revenue?

Answer 50

Money from the sale of goods and services. It is also known as ‘turnover’. It is expressed in terms of money, £. It is calculated by: Revenue = selling price x sales (number of units sold)

Question 51

Costs?

Answer 51

The money that has to be spent to start-up and run the business

Question 52

Fixed costs?

Answer 52

Do not change as output changes. | Rent, business rates, insurance

Question 53

Variable costs?

Answer 53

Change as output changes. If output increases, so do these costs, e.g. raw materials. Variable cost = cost per unit x number of

Question 54

Total costs?

Answer 54

Fixed costs plus variable costs.

Question 55

Average cost?

Answer 55

The cost of producing a single unit of output. | Average Cost = Total Cost ÷ Quantity Produced

Question 56

Profit?

Answer 56

The money left over after all costs have been subtracted from revenue. It is calculated by: Profit = Revenue – Total costs

Question 57

Break even point?

Answer 57

The level of output where total costs equals total revenue. Neither a profit or a loss is made

Question 58

Margin of safety?

Answer 58

Current output - breakeven output

Question 59

Break even output?

Answer 59

Break-even output= Fixed Costs ______________________________ Selling price per unit – variable costs per unit Where Contribution Per Unit = selling price per unit – variable costs per unit

Question 60

Selling price is increased...

Answer 60

- sales revenue line gets cheaper | - BE point decreases

Question 61

Selling price is decreased...

Answer 61

- sales revenue line gets flatter | - BE point increases

Question 62

Variable costs increase...

Answer 62

- variable cost line gets steeper, so total cost line gets steeper - BE point increases

Question 63

Variable costs decrease...

Answer 63

- variable cost line gets flatter, so total cost line gets flatter - BE point decreases

Question 64

Fixed costs increase...

Answer 64

- fixed cost line gets higher, so total cost line is also shifted up - BE point increases

Question 65

Fixed costs decrease...

Answer 65

- Fixed cost line falls, so total cost line shifts down | - BE point decreases

Question 66

Advantages of break-even?

Answer 66

- It is quick to do - the break-even point and Margin of Safety can be established almost immediately. This means managers can take rapid action to reduce costs or increase sales if they need to increase their margin of safety and profits, thereby increasing the likelihood of business success. - Can be used to test whether a new business venture is likely to be profitable and therefore worthwhile. - It can be used to assess the impact of changes in variable costs, fixed costs and selling price on the break-even point and margin of safety

Question 67

Disadvantages of break-even?

Answer 67

- Break-even charts assume the total revenue line is straight. This may not be the case if a business offers customer discounts for large orders. - It is only as accurate as the information on which it is based. If cost data is inaccurate this could lead to wrong conclusions and decisions being made. - Break-even charts assume the total cost line is straight. This may not be the case if a business benefits from purchasing economies of scale by bulk buying. - It assumes that a business will sell all the products it produces. This is unrealistic as businesses hold stocks of finished goods so they can meet increases in customer demand

Question 68

Sales revenue?

Answer 68

The money a business receives from selling its goods or services

Question 69

Cost of sales?

Answer 69

The direct costs of the business, The costs incurred in producing the goods or providing the service, e.g, raw materials

Question 70

Gross profit?

Answer 70

Sales revenue - cost of sales

Question 71

Over heads?

Answer 71

Indirect costs which cannot be identified with a particular unit of output. Incurred by the whole business, e.g, office staff salaries

Question 72

Operating profit?

Answer 72

Gross profit - expenses

Question 73

Statement of comprehensive income/profit and loss account?

Answer 73

-A financial statement that shows a firm’s income and expenditure and resulting profit or loss over a given period of time, usually a year. It contains the following in this order: Revenue, Cost of Sales, Gross Profit, Administrative Expenses, Other Operating Expenses, Selling Expenses, Operating Profit, Finance Costs, Profit for the Year, Tax, Profit for the year after tax. -Profit for the year after tax may be retained in the business for use in the future or distributed to shareholders as dividends.

Question 74

Investment decisions?

Answer 74

Businesses might invest to grow the business, e.g. by developing new products, buying new equipment or building factories. Businesses are more likely to invest if the Statement of Comprehensive Income shows profits are improving

Question 75

Cost analysis?

Answer 75

If costs have increased sharply between the previous and the current year then a business will want to know why and what type of costs have increased so it can take action to reduce costs and improve profits

Question 76

Forecasts of future profit?

Answer 76

Shareholders expect to be told how much profit a business expects to make in the future and a business can use current profits as a basis for this prediction.

Question 77

Making comparisons?

Answer 77

Investors might compare the statements of comprehensive income of different businesses to decide which to invest in and which are most likely to give the best return on their investment.

Question 78

The nature of profit and its importance?

Answer 78

- Businesses exist to make a profit. It is the reward for individuals taking a risk to set up a business. If profits are not sufficient then an entrepreneur may decide to close the business. - The profit levels of an industry determine whether money flows into and is invested in an industry. For example social media is a growing area attracting investment whereas the production and sale of DVDs is declining (HMV has recently gone into administration). - Profit is a measure of judging how successful a business is. Businesses that meet customer needs at a price customers are prepared to pay and at the right quality will be most successful.

Question 79

Statement of Financial position (also called BALANCE SHEET?

Answer 79

An accounting statement showing an organisation’s assets, liabilities and capital at a single point in time.

Question 80

Assets?

Answer 80

Resources owned or used by a business e.g. buildings, equipment, stock

Question 81

Liabilities?

Answer 81

Debts of the business which provide a source of funds. Something that a business owes, e.g. loans, dividends

Question 82

Non-current assets?

Answer 82

Items owned and used by the business for more than one year. Are used by the business to help generate revenue, e.g. premises and equipment

Question 83

Current assets?

Answer 83

Assets that will be converted into cash within a year. They are shown in order of liquidity: Stock, Trade Receivables, Bank, Cash. Order of liquidity refers to the ease with which the asset can be turned into cash. Trade Receivables: Amounts of money that are owed to a business by its customers. They have purchased goods which are to be paid for at a later date.

Question 84

Current liabilities?

Answer 84

Money owed by a business - debts to be repaid within a year e.g. tax, money owed to suppliers.

Question 85

Net current assets?

Answer 85

- Current Assets – Current Liabilities. - This shows working capital. Working Capital is the amount of money needed to pay for day to day trading. It is used to by resources and pay bills e.g. wages. Businesses may run short of working capital due to a fall in sales or if a business unexpectedly has to pay for things such as machinery breakdowns. Working capital can be improved by an overdraft or delaying payments to suppliers.

Question 86

Non-current liabilities?

Answer 86

Money owed by a business - debts that will be repaid after 12 months. e.g. bank loan.

Question 87

Shareholders’ Equity (also known as Capital and Reserves)?

Answer 87

The money put into the business by the owners. It includes share capital, retained profit and other reserves.

Question 88

Capital employed?

Answer 88

The amount the owners have invested in the business.

Question 89

On a statement of financial position for a limited company, the two numbers which balance are...?

Answer 89

- Net Assets - Capital Employed - Net Assets = Non-Current Assets + Current Assets – Current Liabilities – Non-Current Liabilities OR - Net Assets = Non-Current Assets + Net Current Assets - This makes sense because if a business buys a new asset, e.g. a vehicle, it will appear under non-current assets. However, finance will have to be raised to pay for this and this is shown on the other half of the balance sheet, under shareholders’ equity or non-current liabilities depending on the source of finance.

Question 90

The statement of financial position shows...?

Answer 90

- The value of a business’ assets and liabilities. - What types of assets a business owns and how these have been financed. - How the business is funded (the balance between share capital and loans) - The amount of working capital a business has and whether it is sufficient to fund day to day trading

Question 91

Gross profit margin?

Answer 91

Gross Profit Margin % = Gross Profit x 100 | Revenue

Question 92

Operating profit margin?

Answer 92

-Operating Profit Margin % = Operating Profit x 100 Revenue - The higher the percentage, the better the business is performing! - The operating profit margin shows how well a business controls its costs and overheads. An operating profit margin of over 10% indicates a business is performing very well. If there is a small difference between the gross profit margin and the operating profit margin this indicates that a business’ overheads are low and that it is controlling its costs.

Question 93

Mark up?

Answer 93

-Mark-up% = Profit per Item x 100 Cost per Item -This shows the percentage profit made per item sold. Mark-up can also be used by a business to determine its selling price because it can enable a business to identify a price that covers costs and gives a profit. Price = cost + (cost x percentage mark-up)

Question 94

Return on capital employed?

Answer 94

-Return on Capital Employed (ROCE) % = Operating Profit ————————- Capital Employed - Where Capital Employed = Shareholders’ Equity + Non-Current Liabilities - ROCE shows the profit of a business as a percentage of the amount of money (capital) invested to generate this profit. A business will look to increase the ROCE. It can also be compared with interest rates. If the ROCE is greater than the interest rate then the business can generate a greater return from investing in the business rather than keeping money in the bank.

Question 95

Current ratio?

Answer 95

-Current Ratio = current assets current liabilities - It is suggested that a business should have a current ratio of between 1.5 and 2. - Less than 1.5 and a business may not have enough working capital and may struggle to pay current liabilities. - Greater than 2 and a business may have too much money that is tied up in current assets which could be used more productively.

Question 96

Acid test?

Answer 96

-Acid Test = current assets – stock current liabilities - This is a harder test because stock is subtracted from current assets. - A business cannot use its stock to pay its debts and stock is the hardest current asset to convert into cash. - An acid test less than 1 means the value of its current assets minus stock does not cover its current liabilities so the business may not be able to pay its current liabilities.

Question 97

Liquidity?

Answer 97

- This is concerned with how quickly assets can be turned into cash. It is important because without sufficient cash a business will not survive. - Non-Current Assets are not liquid assets because property and equipment can take a long time to sell. - Current assets are liquid assets and in order of liquidity (the least liquid first) they are stock, trade receivables and cash. - Stock is the least liquid current asset because it cannot be certain if or how much stock will be sold.

Question 98

Comparisons with previous years and or with other business organisations

Answer 98

- The statement of comprehensive income and the statement of financial position shows the information for both the current year and the previous year. This means ratios can be calculated for both years and compared to see if the results of the ratios have improved or got worse. - Ratios can be calculated for different businesses in the same industry, e.g. supermarkets to understand how a business is performing compared to its competitors.

Question 99

Managers?

Answer 99

- To prepare budgets and control cash flow | - Assess performance and set business objectives

Question 100

Employees?

Answer 100

- Negotiate pay increases | - Assess their job security

Question 101

External shareholders?

Answer 101

- To assess how well their investment is performing. - Should they continue to keep their shares or should they invest elsewhere? - How much dividend will they receive?

Question 102

Banks?

Answer 102

- Should they lend business money? | - How likely is it that a business can repay a loan?

Question 103

Suppliers?

Answer 103

- Should they give a business trade credit? | - How likely is it that a business will be able to pay for supplies at a later date?

Question 104

Competitors?

Answer 104

-Would it be a good decision to takeover another business?

Question 105

Tax authorities?

Answer 105

-How much tax, VAT and excise duties should a business pay?

Question 106

Funding?

Answer 106

If working capital is low a business may need to arrange an overdraft or chase-up trade receivables. If a business has a high value of retained profit a business could use this to fund growth instead of taking out a bank loan and paying interest.

Question 107

Cutting costs?

Answer 107

If there is a big difference between the gross profit margin and the operating profit margin this indicates that a business’ overheads are high and that it is not controlling its costs.

Question 108

Increasing profitability?

Answer 108

A business may compare its gross profit margin with its competitors. If the gross profit margin is small compared with competitors then a business may consider whether profit can be improved either by increasing prices or cutting direct costs such as raw materials.

Question 109

Investment decisions?

Answer 109

If the business is in a strong, stable financial position, it may be possible for the business to take a calculated risk and invest in growing and expanding the business.