IGCSE Business Unit 5 Finance

Acid test ratio

Current Assets - Stock / Current Liabilities

Gross Profit Margin

Gross profit/sales revenue x 100

How to solve short term cash flow problems

Increase bank loans Delay payments to suppliers (trade credit) Asking debtors to pay more quickly Delay or cancel purchase of capital equipment.

Capital employed

The long-term and permanent capital invested in a business. It is calculated as: Shareholders' equity plus non-current liabilities

External finance

funds obtained from sources outside of and separate from the business.

Non-current assets

items owned by the business for more than one year.

Non-current liabilities

long-term debts owed by the business.

Current assets

owned by a business and used within one year.

Current liabilities

short-term debts owed by the business.

Liquidity

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

Will banks lend?

A business owner should have the following to get a loan: Cash flow forecast Income statement Details of existing loans Evidence of security (collateral) A business plan

The difference between cash and profit

A business's cash is the balance of their bank account and any physical cash they are holding. Profit is calculated as Sales Revenue - cost of sales - expenses. If the business has debtors these sales won't be included in the bank balance but will be included in sales revenue.

Short term bank loan

An external source of finance in which the business borrows funds from the bank which they will pay back, with interest, over a period of time that is less than 12 months.

Long term bank loan

An external source of finance in which the business borrows funds from the bank which they will pay back, with interest, over a period of time that is longer than 12 months.

Leasing

An external source of finance in which the business can rent machinery, equipment or vehicles for an agreed fee over a specific period of time.

Trade credit

An external source of finance in which the business's supplier allows them to purchase goods without paying for them immediately. Payment must be made within an agreed time period, otherwise the business may have to pay internist on the amount owed, or some other penalty.

Issue of shares

An external source of finance that is only available to private and public limited companies. The business can decide to sell more ownership of the business to investors.

Selling debentures

An external source of finance that is only available to public limited companies. The business takes a loan from the stock market, which is funded by investors investing in the loan which is then paid back over time by the business.

Factoring debt

An external source of finance that is used by businesses that have a lot of debtors (customers that owe the business money) that aren't paying their debts. The business can sell the debt for a discount to a business that will collect the debt for themselves.

Hire purchase

An external source of finance where the business leases machinery, vehicles or equipment and at the end of the lease period the business can purchase the asset.

Crowdfunding

An external source of finance where the business or entrepreneur can request a specific amount of money from the public for a stated project. Members of the public can then donate an amount to the project. The business/entrepreneur only keeps the donations if they reach their target amount.

Government grants and subsidies

An external source of finance. The government may provide a sum of money (grant) to the business that does not have to be paid back, but will need to be used for a specific purpose. Or the government can help with a payment such as rent (subsidies) for a specific period of time.

Owners' savings

An internal source of finance that is only available to sole traders and partnerships. At any time the owner can invest more money into the business.

Sales of inventories

An internal source of finance used by a business that usually holds large amounts of stock. They sell the stock without replacing it which creates a source of income.

Sale of existing assets

An internal source of finance used when the business can sell off some of the items that they own, such as buildings, machinery and equipment.

Retained profit

An internal source of finance used when the business keeps some or all of its profits within the business instead of paying it to the shareholders as dividends.

How to solve long term cash flow problems

Attract new investors Cutting costs and increasing efficiency Developing new products to attract more customers

Surplus

Businesses in the public sector and social enterprises do not make a profit, but this is the term used when their revenue is greater than costs.

Formula for working capital

Current assets - current liabilities

Users of accounts

Managers - to see if targets are being met and the business is efficient Shareholders - to see if their investment is getting a good return Creditors (suppliers) - to see if the business will be able to pay back trade credit. Banks - to see if the business can pay back a loan. Government - to calculate the tax the business should be paying Workers and trade unions - to see if the business can afford to increase wages. Competitors - to compare their performance to the industry standard.

Limitations on ratio analysis

Managers have access to all data but external users will only be able to accessed published data. Ratios are based on historical data and may not be a reliable predictor of future success. Different businesses may use different accounting methods e.g. calculating the value of non current assets.

Return on capital employed (ROCE)

Net profit/capital employed x 100

Net Profit Margin

Net profit/sales revenue x 100

Factors affecting the source of finance

Purpose - what will the source of finance be used for. Time period - how long will it take to repay the source of finance and how long will the business have the asset. Amount needed - how much funding is required. Legal for and size - what is the ownership fo the business - limited company or unlimited company. How big is the business. Control - will the business lose any control by using that source of finance, e.g. by issuing more shares. Risk and gearing - Gearing is the amount of loan the business already has in comparison to its total capital employed. Is the business's gearing already high?

Main Features of the income statement

Revenue - Cost of sales = Gross Profit - Expenses = Net profit

Why profit is important to private sector businesses

Reward for enterprise Reward for risk taking Source of finance Indicator of success

Shareholders' Equity (funds)

Share capital + Retained Profit This is the total amount invested in the business by the shareholders. It tells us the value of the business.

Formula for Capital Employed

Share capital + Retained Profit + Non-current liabilities

Uses of the cash flow forecast

Starting up a business, keeping the bank informed (help to get a loan), managing the existing business, managing cash flow

Overdrafts

This is an external source of finance, whereby the bank allows the business to overspend on the amount that they have in their bank account.

Will shareholders invest?

To attract investors, businesses should consider: Is the share price increasing? Are dividends high? Competition for investment. Reputation for growth

Income statement

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

Trading account

a document that shows how the gross profit of a business is calculated.

Balance sheet

a document that shows the value of a business's assets and liabilities at a particular time.

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 each month.

Final accounts

are 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.

Current ratio

current assets/current liabilities

Internal finance

funds obtained from within the business itself.

Gross profit

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

Revenue expenditure

money spent on day-to-day expenses which do not involve the purchase of a long-term asset, for example wages or rent.

Capital expenditure

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

Micro finance

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

Closing cash (or bank) balance

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

Opening cash (or bank) balance

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

Working capital

the capital available to a business in the short-term to pay for day-to-day expenses.

Cash flow

the cash inflows and outflows over a period of time.

Cost of goods sold

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

Liabilities

the debts owed by the business.

Net cash flow

the difference, each month, between inflows and outflows.

Depreciation

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

Working capital

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

Start-up capital

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

Accounts

the financial records of a firm's transactions.

Sales revenue

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

Retained profit

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

Accountants

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

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.

Cash flow cycle

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

Cash outflows

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

Cash inflows

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

Profit

the surplus after total costs have been subtracted from sales revenue.

Illiquid

this means that assets are not easily convertible into cash.

Assets

those items of value which are owned by the business. They may be fixed (non-current) assets or short-term (current) assets.