Financial information and decisions

Financial information

Figures, reports, data and analysis showing how a business is performing financially.

Purpose of financial information

To help a business understand its financial performance, make decisions, plan for the future and see whether it is making a profit or loss.

Users of financial information

Owners, managers, employees, banks/lenders, investors, suppliers and the government can use financial information to make decisions.

Equity

The amount of money that would be left for the owners/shareholders if all the business's assets were sold and all liabilities were paid. Equity = Assets - Liabilities.

Assets

Resources owned or controlled by a business that are expected to provide a future benefit, such as cash, vehicles, machinery and buildings.

Current assets

Assets expected to be turned into cash or used within one year, such as cash, inventory and accounts receivable.

Non-current assets

Assets kept and used by a business for more than one year, such as buildings, vehicles, machinery and equipment.

Capital

Money put into a business by its owners or money used to build, run or grow the business.

Revenue

Money earned by a business from selling goods or providing services.

Sales revenue

The money a business makes from selling its products or services.

Sales revenue formula

Sales revenue = Selling price × Units sold.

Expenses

Money leaving a business to pay for things such as wages, rent, supplies and services.

Fixed costs

Costs that stay the same even when the amount produced or sold changes, such as rent or insurance.

Variable costs

Costs that change when the amount produced or sold changes, such as raw materials or packaging.

Semi-variable costs

Costs that have both a fixed part and a variable part. For example, a phone bill may have a fixed monthly charge plus charges based on usage.

Liabilities

Money that a business owes to other people or organisations and must pay back.

Market share

The percentage of total sales in an industry that a particular business has.

Dividends

Payments of profit made to shareholders.

Profit

The amount left when a business's income is greater than its expenses. Profit = Income - Expenses.

Loss

When a business's expenses are greater than its income.

Internal finance

Money raised from within the business, such as money invested by the owners or money generated from business sales/profits.

External finance

Money raised from outside the business, such as bank loans or finance companies. It usually has to be repaid and may involve interest.

Short-term finance

Finance used for day-to-day needs, such as paying wages, rent and buying stock. It is normally needed for less than one year.

Medium-term finance

Finance usually used to buy assets needed to run the business, such as computers, equipment or machinery.

Long-term finance

Finance used for large or long-lasting needs, such as buying business premises or other long-term assets.

Owner's capital

Money put into the business by the owner. It is an example of internal finance.

Retained profit

Profit kept in the business instead of being paid to the owners. It can be used to fund future business activities.

Bank loan

Money borrowed from a bank that is repaid over an agreed period, usually with interest.

Advantages of internal finance

It does not usually involve interest payments, does not create debt, and the business keeps control over how the money is used.

Disadvantages of internal finance

The business may not have enough money available, and using savings or retained profit means that money cannot be used elsewhere.

Advantages of external finance

It can provide more money than the business currently has and allows the business to buy assets or expand sooner.

Disadvantages of external finance

It may create debt, usually involves interest or other costs, and repayments must be made even if the business is struggling.

Advantages of short-term finance

It is useful for immediate cash-flow needs and can help a business pay its day-to-day expenses.

Disadvantages of short-term finance

The business has to repay the money relatively quickly, which can put pressure on cash flow.

Advantages of long-term finance

It gives the business more time to repay and is suitable for expensive long-term investments.

Disadvantages of long-term finance

The business may pay a large amount of interest over time and is committed to repayments for longer.

Break-even

The point where total revenue equals total costs, so the business makes neither a profit nor a loss.

Break-even formula

Break-even units = Fixed costs ÷ Contribution per unit.

Contribution

The amount each unit sold contributes towards covering fixed costs and then making a profit.

Contribution per unit formula

Contribution per unit = Selling price per unit - Variable cost per unit.

Uses of break-even

Break-even can show how many units need to be sold before a business makes a profit, help with pricing and production decisions, and show the effect of changing costs or selling prices.

Break-even chart

A graph showing costs, revenue and the break-even point at different levels of output.

Budget

A plan showing a business's expected income and expenses over a future period of time.

Purpose of a budget

A budget helps a business plan ahead, control spending, set targets, manage cash and compare expected results with actual results.

Estimated income

The amount of money a business expects to receive during a future period.

Estimated expenditure

The amount of money a business expects to spend during a future period.

Budget surplus

When estimated income is greater than estimated expenditure.

Budget deficit

When estimated expenditure is greater than estimated income.

How a budget is prepared

A business estimates its future income and expenses, records them for a set period, calculates the expected surplus or deficit, and uses the results to plan.

Advantages of setting a budget

It helps with planning, controls spending, sets financial targets, identifies possible problems early and helps a business make decisions.

Disadvantages of setting a budget

Budgets are based on estimates, so unexpected changes can make them inaccurate. Preparing and monitoring them can also take time.

Variance

The difference between a budgeted or expected figure and the actual figure.

Variance analysis

The process of comparing planned/budgeted figures with actual results to find differences and understand why they happened.

Favourable variance

A variance that has a positive effect compared with the budget, such as higher-than-expected revenue or lower-than-expected costs.

Unfavourable variance

A variance that has a negative effect compared with the budget, such as lower-than-expected revenue or higher-than-expected costs.

Importance of variance analysis

It helps a business find problems, understand performance, control costs and make better decisions for the future.

Financial records

Records of the actual financial transactions of a business, which can be used to prepare financial reports.

Income statement

A financial statement showing a business's revenue, costs and profit or loss over a period of time.

Purpose of an income statement

It shows how well a business performed financially over a period and whether it made a profit or loss.

Cost of goods sold

The cost to a business of buying or producing the goods that it sold.

Cost of goods sold formula

Cost of goods sold = Cost per unit × Units sold.

Gross profit

The profit made from selling goods before other business expenses are taken away.

Gross profit formula

Gross profit = Sales revenue - Cost of goods sold.

Net profit

The final profit after all business expenses have been deducted.

Net profit formula

Net profit = Gross profit + Other income - Expenses.

How an income statement is used

It can be used to see whether the business is profitable, compare performance over time and help owners and managers make decisions.

Profitability

The ability of a business to make profit from its revenue and resources.

Gross profit margin

A profitability ratio showing how much gross profit is made from each dollar of sales revenue.

Gross profit margin formula

Gross profit margin = (Gross profit ÷ Sales revenue) × 100.

Net profit margin

A profitability ratio showing how much net profit is made from each dollar of sales revenue.

Net profit margin formula

Net profit margin = (Net profit ÷ Sales revenue) × 100.

Return on capital employed (ROCE)

A profitability ratio showing how effectively a business uses the capital invested in it to generate profit.

ROCE formula

ROCE = (Net profit ÷ Capital employed) × 100.

Improving profit

A business can improve profit by increasing sales revenue, increasing prices where possible, reducing costs, improving productivity, reducing waste or selling more profitable products.

Ways to increase revenue

A business can increase revenue by selling more units, increasing prices, improving marketing, entering new markets or increasing its market share.

Ways to reduce costs

A business can reduce costs by finding cheaper suppliers, reducing waste, improving efficiency, reducing unnecessary spending or using resources more effectively.

Statement of Financial Position (SOFP)

A financial statement showing what a business owns, what it owes and the owner's equity at a particular point in time.

Purpose of the SOFP

It shows the financial position of a business by listing its assets, liabilities and equity at a specific date.

Current liabilities

Debts and obligations that a business expects to pay within one year, such as short-term loans and amounts owed to suppliers.

Non-current liabilities

Debts and obligations that are due to be paid after more than one year, such as long-term loans or mortgages.

Owners' equity

The owners' claim on the assets of the business after liabilities have been deducted.

Accounting equation

Assets = Equity + Liabilities.

Net assets

Total assets minus total liabilities. Net assets are equal to owners' equity.

Liquidity

The ability of a business to pay its short-term debts and day-to-day expenses when they are due.

Importance of liquidity

A business needs enough liquid assets to pay its short-term debts and expenses. Poor liquidity can cause cash-flow problems even if the business is profitable.

Current ratio

A liquidity ratio comparing current assets with current liabilities.

Current ratio formula

Current ratio = Current assets ÷ Current liabilities.

Interpreting the current ratio

A higher current ratio generally means the business has more current assets available to cover its short-term liabilities.

Quick ratio

A liquidity ratio that measures whether a business can pay its current liabilities using its most liquid current assets, without relying on selling inventory.

Quick ratio formula

Quick ratio = (Current assets - Inventory) ÷ Current liabilities.

Liquidity vs profitability

Liquidity is about being able to pay short-term debts, while profitability is about making a profit.

Why a business needs finance

A business may need finance to start up, buy assets, pay day-to-day expenses, expand, buy stock, replace equipment or fund new projects.

Internal vs external finance

Internal finance comes from within the business, while external finance comes from outside the business.

Short-term vs long-term finance

Short-term finance is used for needs usually lasting less than a year, while long-term finance is used for longer-lasting investments and commitments.

Fixed cost example

Rent is usually a fixed cost because it normally stays the same even if the business sells more or fewer products.

Variable cost example

Raw materials are usually a variable cost because the amount needed changes when production changes.

Semi-variable cost example

A telephone bill can be semi-variable because it may include a fixed monthly charge plus a variable charge based on usage.

Gross profit vs net profit

Gross profit is sales revenue minus the cost of goods sold, while net profit is what remains after other expenses have also been deducted.

Revenue vs profit

Revenue is the money earned from sales, while profit is the amount left after costs and expenses are deducted.

Assets vs liabilities

Assets are resources the business owns or controls, while liabilities are amounts the business owes.