5.3 Income statements

Why a business requires finance:

• start up capital (finance needed by new businesses to pay for non-current and current assets before it can begin trading)

• revenue expenditure (money spent on day-to-day expenses *do not involve the purchases of long-term assets)

• capital expenditure (money spent on non-current assets which will last for more than a year)

Accounts: the financial records of a firm’s transactions

Income statements: a financial statement that records the income of a business and all costs incurred

Profit can be increased by increasing total revenue or decreasing total costs.

Profit = Total revenue - Total costs

Why do businesses produce accounts:

• it is a legal requirement

• sums up the performance of a business to its stakeholders

• can be compared with the previous years’ performance

• investors or lenders need to see one before making deals

• can help to forecast future profits and help with planning

Cash: the actual money the business has in its bank account

Trading account: shows the information at the top of a cashflow forecast (revenue and cost of sales), and how to calculate gross profit

Why is it important to know profit:

• it acts as a measure of success

• measures the performance of managers

• can provide finance for future expansions and the purchase of non-current assets

Revenue/sales/sales revenue/total revenue: the amount earned from the sales of products

Revenue = selling price x quantity of units sold

Cost of sales: the cost of purchasing the goods used to make the products sold

Cost of sales = cost per unit x number of sales Gross profit: the difference between revenue and cost of sales

Gross profit = revenue - cost of sales

Expenses: the day-to-day costs of running a business

Net profit: the actual profit after expenses (not including gross profit) have been paid

Net profit = gross profit - expenses/overheads

Importance of profit to private sector businesses:

• Reward for enterprise - entrepreneurs may have important qualities and characteristics and profit rewards them for this)

• Reward for risk taking - profits rewards entrepreneurs for taking risks and allowing payments to be made

• Source of finance - profits after payments to owners are a very important source of finance for businesses

• Indicator of success - if some businesses are profitable, profit can be an indicator for other businesses as to whether producing similar goods or services would be profitable

5.4 Statement of financial position

Statement of financial position: a financial account which shows what the business is worth at any given period of time

Balance sheet: shows the value of a business’ assets and liabilities at a particular time

Business assets: something owned by the business

Liabilities: something owed by the business

Capital: money invested into the business by the owners

Income statement: shows if the business is making a PROFIT or LOSS

Assets - Inventories, Van/truck, Debtors, Cash

Liabilities - Overdrafts, Mortgages, Trade creditors

Non-current assets (fixed): assets kept by the business for more than a year e.g. land, machinery

Current assets (short-term): assets kept by the business for less than one year e.g. cash, inventory

Debtors: customers who owe the business money

Non-current liabilities: amounts that do not have to be paid back within a year e.g. bank loans, mortgages

Current liabilities: amounts that must be paid back within one year e.g. bank overdraft, trade credit

Trade credit: amounts owed to suppliers

Shareholders’ equity: the total sum of money invested in the business by the owners of the company

The money is invested in 2 ways:

• Share capital - the money put into the business when the shareholders buy newly issued shares

• Reserves - basically retained profit that has not been paid out to the shareholders in dividends

Dividends: payments made to shareholders from the profits of a company. They are the return to shareholders for investing in a company.

Working capital: current assets - current liabilities

Capital employed: shareholders funds + non-current liabilities

Total net assets = total equity

5.4 Statement of financial position

Profit: the amount of money a business has made after all costs have been paid.

Profitability: a measure of performance, how good a business is at turning sales into profit.

Profitability is measured in percentage form, and is therefore a measure of efficiency and can be used to compare the business’ performance over a number of years.

Profitability is important to:

• investors when deciding which business to invest in

• directors and managers of the business to assess if the business is becoming more or less successful over time

Profitability ratios:

Return on capital employed (ROCE) = net profit / capital employed x 100

Gross profit margin (GPM) = gross profit / sales x 100

Net profit margin (NPM) = net profit / sales x 100

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

Liquidity ratios:

Current ratio = current assets / current liabilities

Current ratio shows whether a business can pay back its current liabilities from its current assets.

Acid test ratio = current assets - inventories / current liabilities

The liquidity ratios are always written in the form x:1 and if the x value is not more than one, then the business doesn’t have enough to pay off short-term debts.

Users of accounts and what they use accounts for:

Managers - making decisions and controlling operations of a firm

Shareholders - want to know how big of a profit or loss the business has made, and to assess the liquidity of a business

Banks - decide if the firm should be given a loan

Government - want to check the tax the company is paying

Workers and trade unions - will want to assess the security of the company in the future

Other businesses - to see if the other business is a threat

4.1 Production of goods and services

Labour intensive production: many workers and few machines

Capital intensive production: business uses machinery and employs few workers

The Operations department:

Factory manager - is responsible for the quantity and quality of the products coming off a production line

R & D (research and development) manager - is responsible for the design and testing of new production processes and products

Purchasing manager - is responsible for providing the materials, components and equipment required for production

Retail/service manager - is responsible for the employees in a shop * same role as a factory manager but in a shop

Productivity - the output measured against the inputs used to create it, how a business can measure its efficiency

Ways to increase productivity:

• Improve quality control / assurance reduces waste

• Improve employee motivation

• Introduce new technology

• Improve inventory control

• Train staff to be more efficient

• Use machines instead of people to do jobs (automation)

Benefits of increasing efficiency:

• Reduced inputs needed for the same output level

• Lower costs per unit (average cost)

• Fewer workers may be needed, possibly leading to lower wage costs

• Higher wages may now be paid to workers, which increases motivation

Job production: products are made specifically to order. Each order is different, and may or may not be repeated. e.g. tailored suits, wedding dresses

Advantages

• Workers have more varied tasks

• Products are specialised and so can be sold for more

Disadvantages

• Skilled workers are employed, raising costs

• It is labour intensive, so costs are high

• Production is time consuming

Batch production: similar products are made in blocks or batches. A certain number of a product is made, then a certain number of another product is made, and so on. e.g. bread, furniture

Advantages

• There is some variety in the workers’ jobs

• Time efficient

• Flexible way of working and production can be changed from one product to another easily

Disadvantages

• Expensive

• Storage space needed for inventories, which is costly

• Machines have to reset between batches so there is a delay in production and output is lost

Flow production: large quantities of a product are produced in a continuous process, sometimes referred to as mass production. e.g. cars, cameras, TVs

Advantages

• High outputs

• Low prices

• Increased efficiency because capital intensive methods can be used

Disadvantages

• Boring for the workers, so workers are unmotivated

• Significant storage space needed

• Cost of raw materials can be high

• If one machine breaks, the whole production line stops

Factors affecting methods of production:

• The nature of the product

• The size of the market

• The nature of demand

• The size of the business

Buffer stock/inventory: the inventory held to deal with uncertainty in customer demand and deliveries of supplies

Reorder level: a point before inventory runs out that the business orders more inventory - because the order will take time to arrive

Lead time: time taken for goods ordered to be delivered

Maximum stock level: the maximum amount of stock a business can hold

Lean production: used by businesses to cut down on waste and therefore increase efficiency

Lean production methods:

Kaizen: means ‘continuous improvement’ and focuses on the elimination of waste, e.g. getting rid of large amounts of inventory or reducing the amount of time taken for workers to walk between jobs, so that they eliminate unnecessary movements.

Advantages

• Reduced amount of space needed for the production process

• Improved layout of the factory floor may allow some jobs to be combines, freeing up employees to carry out other jobs

• Work in progress is reduced

Just-in-time production: a method ensuring that goods are received from the suppliers only as they are needed in the production process. The objective of this is to save warehouse space and reduce unnecessary costs.

Advantages

• Reduces the costs of holding inventory

• Warehouse space is not needed, again reducing costs

• The finished product is sold quickly and so money come back into the business more quickly

Cell production: when the production line is divided into separate units, each one focused on making a different part of the product.

Advantages

• Workers are motivated as they have a variety of roles

• Workers become multi-skilled

• Quality improves, reducing waste and saving costs

• Improves communication between workers

Technology in production:

Manufacturing

Automation - The pro: tion line consists mainly of machines and few people are needed to ensure the production line runs smoothly.

Mechanisation - Production is done by machines but operated by people

CAD (Computer aided design) - Computer software use to design products

CAM (Computer aided manufacture) - Computers monitor the production process and control machines or robots producing the product

CIM (Computer integrated manufacturing) - Integration of CAD and CAM. The computer that design the products are linked directly to the computers that aid the manufacturing process

Payment systems

EPOS (Electronic point of sale) - Operator scans the barcode of each item individually. The inventory record automatically changes to show the item has been sold and if inventory is low, then more inventory is automatically ordered.

EFTPOS (Electronic funds transfer point of sale) - The electronic cash register is connected to the retailer’s main computer and also to banks over a wide area computer network.

Contactless payments - Is a quick and easy way to pay for purchases under a certain amount. Sometimes larger transactions require a passcode, fingerprint or some other way to ensure it is a correct transaction.

Advantages of new technology

• Productivity is greater as new, more efficient production methods are used

• Greater job satisfaction stimulates workers as boring jobs are now done by machines

• Better quality products are produced

• Quicker communication and reduced paperwork

Disadvantages of new technology

• Unemployment could increase as machines/capital replace workers

• It is expensive to invest in new technology and machinery, and large quantities of products need to be sold to cover the cost of purchasing the equipment

• Employees may not be happy with the changes in their work when new technology is introduced

• Technology becomes outdated quickly and needs to be replaced, which is expensive, if the business is to remain competetive.