Unit 5 - Business Studies IGCSE

Start-up capital

the finance needed by a new business to pay for essential fixed and current assets before it can begin trading.

Working capital

the finance needed by a business to pay its day-to-day costs.

Capital expenditure

money spent on fixed assets which will last more than one year.

Revenue expenditure

money spent on day-to-day expenses which do not involve the purchase of a long-term asset.

Internal finance

obtained from within the business itself.

External finance

obtained from sources outside of and separate from the business.

Micro-finance

providing financial services - including small loans - to poor people not served by traditional banks.

Short-term source of finance

finance that must be paid back within a year and includes : overdraft facility, trade credits, factoring.

Long-term source of finance

funding obtained for a time frame exceeding one year in duration and includes : owner's savings, debentures, loans, share capital, a mortgage, hire purchase or leasing, grants.

Cash flow

the cash inflows and outflows over a period of time.

Cash inflows

the sums of money received by a business during a period of time.

Cash outflows

the sums of money paid out by a business during a period of time.

Cash flow cycle

shows the stages between paying out cash for labour, materials, etc. and receiving cash from the sale of goods.

Profit

surplus after total costs have been subtracted from sales revenue.

Cash flow forecast

an estimate of future cash inflows and outflows of a business, usually on a month-by-month basis. This then shows the expected cash balance at the end of the month.

Opening cash (or bank) balance

amount of cash held by the business at the start of the month.

Net cash flow

difference, each month, between inflows and outflows.

Closing cash (or bank) balance

amount of cash held by the business at the end of each month. This becomes next month's opening cash balance.

Accounts

financial records of a firm's transactions.

Accountants

professionally qualified people who have responsibility for keeping accurate accounts and for producing the final accounts.

Final accounts

produced at the end of the financial year and give details of the profit or loss made over the year and the worth of the business.

Income statement

document that records the income of a business and all costs incurred to earn that income over a period of time. It is also known as a profit and loss account.

Gross profit

made when sales revenue is greater than the costs of goods sold.

Sales Revenue

the income to a business during a period of time from the sale of goods or services.

Cost of goods sold

the cost of producing or buying in the goods actually sold by the business during a time period.

Trading account

shows how the gross profit of a business is calculated.

Net Profit

the profit made by a business after all costs have been deducted from sales revenue. It is calculated by subtracting overhead costs from gross profits.

Depreciation

the fall in the value of a fixed asset over time.

Retained profit

net profit reinvested back into a company, after deducting tax and payments to owners, such as dividends.

Dividends

annual payments from company profits to shareholders.

What do Finance departments do?

- record all financial transactions

- prepare final accounts

- produce accounting information for managers

Why do businesses need finance?

- Start up a business

- Expand an existing business

- Increase working capital

Internal Sources of Finance

- Retained profits

- Selling inventories - reducing inventory levels

- sale of surplus assets

- sole trader or partnership - owner's savings

External Sources of Finance

- bank loans

- micro-finance

- debentures

- sell debts to debt factor

- grants and subsidies from government

- sale of shares - limited company

Short term finance

- overdrafts from bank

- debt factoring

- trade creditors - delay paying suppliers

Long term finance

- leasing

- hire purchase

- loans

- debentures

- sale of shares (rights and new issue)

Choosing sources of finance

- purpose and period of time required

- amount required

- risk and gearing

- status and size of business

- control over the business

Will banks lend?

- Is a cash flow forecast available?

- Is a business plan available?

- Is a forecasted income statement available?

- Why is the loan needed?

- What is the gearing ratio?

- Will the loan be secured?

Will shareholders invest?

- Are the future prospects for the company good?

- How do company dividends compare with those from other companies?

- What is the gearing ratio?

- How has the company's share price varied?

What will happen if the business is facing financial problems?

- unable to pay workers, suppliers, landlord, government

- production of goods and services will stop

- the business may be forces into liquidation

Cash flow cycle process

1 cash needed to pay for

2 materials, wages, rent, etc

3 goods produced

4 goods sold

5 cash payment received for goods sold

Uses of cash flow forecasts

- starting up a business

- running an existing business

- keeping the bank manager informed

- managing cash flow

How can cash flow problems be overcome?

- Increasing bank loans

- Delaying payments to suppliers

- Asking debtors to pay more quickly or insisting to pay in cash only

- Delay or cancel purchases of capital equipment

Working capital formula

current assets - current liabilities

How is a profit made?

1 increasing sales revenue by more than costs

2 reducing cost of making products

3 a combination of both 1 and 2

Why is a profit made?

- Reward for enterprise

- Reward for risk taking

- Source of finance

- Indicator of success

Gross Profit

Sales Revenue - COGS

Net Profit

Gross Profit - Expenses (Overhead)

Retained Profit

Net Profit (after interest and tax) - Dividends

Income statements

- gross profit = sales revenue - COGS (cost of goods sold)

- net profit = gross profit - expenses/overheads

- retained profit = net profit - tax and dividends

- shows profit/loss, not cash flow

- used by managers to compare business performance

- important part of a company's published accounts

Balance Sheet

shows the value of a businesses' assets and liabilities at a particular time. Statement of financial position

Assets

those items of value which are owned by the business.. current or fixed

Liabilities

debts owed by the business

Fixed assets

items owned by the business for more than one year

Current assets

owned by a business and used within one year

Long-term liabilities

long-term debts owed by the business

Current liabilities

short-term debts owed by the business

Liquidity

ability of a business to pay back its short-term debts

Capital employed

shareholders' equity plus long-term liabilities and is the total long-term and permanent capital invested in a business.

Illiquid

assets that are not easily convertible into cash.

Managers

use the accounts to help them keep control over the performance of each product or division of the business. They will be able to identify which parts of the business are performing well or poorly.

The ratios can be helpful as managers are able to compare their company's performance and liquidity.

Profitability ratio 1: return on capital employed

net profit/capital employed x 100%

Gross Profit Margin

gross profit / sales revenue x 100%

Net Profit Margin

net profit / sales revenue x 100%

Current Ratio (Liquidity)

Current Assets/Current Liabilities, a liquidity ratio.

Acid Test Ratio

Current Assets - Stock / Current Liabilities

Shareholders

Income statement: the higher the profitability ratios are, the more likely the shareholders will want to invest by buying more shares in the company

Creditors

If the results indicate a liquidity problem, they might refuse to supply goods on credit

Banks

If the results suggest being illiquid, a bank would not be willing to lend more

govt

check the profit tax paid by the company

if the comp is making a loss, this might be bad news for the govt's control of the whole economy, especially if it means that workers' jobs may be lost

workers and trade unions

future of the company secure or not

if the manager says cannot afford a pay rise, they can see if the profits of the comp are increasing or not

other business

managers of another business will be considering a bid to take over the company or they may just wish to compare the performance and the profitability of the business

limitations of using acccounts and ratio analysis

-managers will have access to all accounts data, but the external users will only be able to use the published accounts which contain only data required by the law

-ratios are based on past accounting data and may not indicate how a business will perform in the future

-accounting data over time will be affected by inflation, and comparisons between years may be misleading

-diff comp may use slightly diff accounting methods for example in valuing their fixed assets. these different methods could lead to different ratio results, therefore making comparisons difficult.

working capital

cuurent assets - current liabilities

shareholders funds

total assets - total liabilities

interpreting balance sheet data

see if their stake in the business has increased or fallen in value over the last 12 months by looking at the total equity figures for 2 years