Unit 5: Finance and accounting

Key terms

Start-up capital

the capital needed by an entrepreneur to set up a business.

Working capital

the capital needed to pay for raw materials, day-to-day running costs and credit offered to customers.

Short-term finance

money required for short periods of time of up to one year.

Long-term finance

money required for more than one year.

Profit

the value of goods sold (revenue) less costs.

Liquidity

the ability of a business to pay it's short-term debts.

Administration

when administrators manage a business that is unable to pay its debts with the intention of selling it as a going concern.

Bankruptcy

the legal procedure for liquidating a business (or property owned by a sole trader) which cannot fully pay its debts out of its current assets.

Liquidation

when a business ceases trading and its assets are sold for cash to pay suppliers and other creditors.

Current assets

assets that either are cash or likely to be turned into cash within 12 months (inventory and trade receivables or debtors).

Current liabilities

debts that usually have to be paid within one year.

Capital expenditure

the purchase of non-current assets that are expected to last for more than one year, such as building and machinery.

Revenue expenditure

spending on all costs and assets other than non-current assets, which includes wages, salaries and inventory of materials.

Internal sources

raising finance from the business's own assets or from profits left in the business (retained earnings)

External sources

raising finance from sources outside the business, for example banks.

Non-current assets

assets kept and used by the business for more than one year.

Overdraft

a credit that a bank agrees can be borrowed by a business up to an agreed limit as and when required.

Factoring

selling of claims over trade receivables (debtors) to a specialist organisation (debt factor) in exchange for immediate liquidity.

Hire purchase

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 payment has been made.

Leasing

obtaining the use of an asset and paying a leasing charge over a fixed period, avoiding the need to raise long-term capital to buy the asset. The asset is owned by the leasing company.

Long-term loans

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

Debentures

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

Share (or equity) capital

permanent finance raised by companies through the sale of shares.

Business mortgages

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

Venture capital

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.

Collateral security

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.

Rights issue

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

Microfinance

providing financial services for poor and low-income customers who do not have access to banking services, such as loans and overdrafts offered by traditional commercial banks.

Crowd funding

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

Cash flow

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

Insolvent

when a business cannot meet its short-term debts.

Cash flow forecast

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

Cash inflow

cash payments into a business.

Cash outflow

cash payments out of a business.

Net cash flow

estimated difference between cash inflows and cash outflows for the period (for example one month).

Opening cash balance

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

Closing cash balance

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

Credit control

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

Bad debt

Unpaid customers' bills that are now very unlikely to ever be paid.

Overtrading

expanding a business rapidly without obtaining all of the necessary finance, resulting in a cash flow shortage.

Break-even point

the level of output at which total costs equal total revenue, when neither a profit nor a loss is made.

Cost centre

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

Direct costs

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

Indirect costs

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

Fixed costs

costs that do not vary with output in the short run.

Variable costs

costs that vary with output.

Total cost

variable cost + fixed cost.

Profit centre

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

Average cost

total cost divided by the number of units produced.

Full costing

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

Contribution costing

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

Marginal cost

the additional cost to a firm of producing one more unit of output.

Break-even analysis

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

Margin of safety

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

Contribution per unit

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

Budgeting

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

Budget holder

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

Variance analysis

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

Delegated budgets

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

Incremental budgeting

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

Zero budgeting

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

Favourable variance

A change from a budget that leads to higher than expected profits.

Flexible budgeting

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

Adverse variance

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