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Business Studies U3
Business Studies Unit 3
| Question | Formula/Definition | Benefits/Limitations |
|---|---|---|
| What are the 5 categories of Ratio Analysis? | Liquidity Ratios Profitability Ratios Financial Efficiency Ratios Gearing Ratios Shareholders Ratios | (blank) |
| Briefly describe Liquidity Ratios | 1. current ratio 2. the acid-test ratio | measure the main solvency of the business and its ability to meet short term debts |
| Briefly describe Profitability Ratios | 1. gross profit margin 2. net profit margin 3. Return on capital employed (ROCE) | analyse the profit made over the last year |
| Briefly Describe Financial Efficiency Ratios | 1. asset turnover ratio 2. stock turnover ratio 3. debtors day ratio | analyse the efficiency of the business in terms of the use of its resources in generating sales |
| Briefly describe Gearing Ratios | (Long term liability x 100)/Capital employed measures long-.term liquidity, high gearing is acceptable if busines grow quickly | measure the proportion of capital of business that have come from external sources and must be repaid with interest if too high->firm vulnerable to increased interest rates->lower returns->dividends->retained profit->loose investors, |
| Briefly describe Shareholders Ratios | 1. EPS -> Earing per share 2. P/E -> Price/Earing ratio 3. Dividend per share 4. Dividend yield 5. Dividend cover | measure the strenghts of the company its share price and dividends |
| The current ratio | current assets / current liabilities Typical figure for current ratio is 1.6:1 due to just-in-time system of production. | Fast-food outlets operate with lower rations, if too high->not investing->not generating income->opportunity cost, too low->liquidity crisis. Can be improved: 1. seeling of fixed assets, 2.negotiating long-term loan , 3.short-term borrowing(interest!!) |
| Acid Test Ratio | (current assets - stock) / current liabilities 1:1, of recenetly 0.7:1, Retailers even 0.4:1 as they mainly trade with cash and have close relationships with suppliers | measures very short-term liquidity!shows firms ability to pay its bills over 2-3months period, more accurate as stock can take time to sell!as liquidity ratios are based on balance sheet one has to be carefull (snapshot figure!, may be unrepresentative. |
| Working Capital | Current Assets - Current liabilities ->to ensure sufficient liquidity it should be between 1.5 and 2 times of current liab. | provides business with cash to finance their day-to-day spending, also called Net Current Assets |
| Reserves | profit accumulated during previous years trading which is NOT paid out to the owners, represent increase in value of business | not necessarly cash but (fixed) assets |
| Intellectual capital | patents, copyrights, trademarkds and brand names | (blank) |
| Other name for "owners fund" | Capital and reserves heading for 1. Retained profit 2. share capital | 1. equals "net assets" in balance sheet 2. are a liability for business->money that it owes 3. includes share capital and Retained profit |
| Why can Sainsburies liabilities exceed the assets available for the same period? | bcs. customers, pay cash as they shop -> steadily inflow of money over the year-> assisting its cash position | (blank) |
| A sudden increase in fixed assets may indicate? | rapidly growing company-> financial performance may improve->overtrading? | (blank) |
| What are examples of Window dressing? | 1. borrowing money for short period->improves cash position, 2. sale of assets and leaseback, 3. exess value of intangible assets, 4. Capitalising expenditure | (blank) |
| What does the term capitalising expenditure stand for? | including items as fixed assets in the balance sheet , which might normally be regarded as expenses, i.e. computer software | (blank) |
| Why is the balance sheet important? | 1. measure of value of firm, over time trend can emerge, 2. shows gearing, overborrowing, 3. if expensive short-term finances have been used too much, 4. illustrates liquidity , ability to meet debts and liabilities over next months. | 1. other sources of info are needed, such as P&L Account, 2. historical documents, 3. does not provide real insights such as qualitiy of management, degree of competition, change in external enviroment, sudden alteration in consumer tastes etc.. |
| Define Term Creditors | short-term suppliers / current liabilites / short term debts of business | (blank) |
| How are total assets calculated? | Fixed Costs + Current Costs | (blank) |
| How are Total Liabilites calculated? | Capital & reserves + Long-term liabilities + Creditors = Total Liabilities | (blank) |
| Explain why "positive cash flow" is important to businesses. | positive cash flow is where cash receipts exceed cash payment. Businees need "pcf" to pay employees' wages, pay suppliers raw materials, pay shop rent etc. | negative cash flow means business may need to borrow, which costs interest->reduce profit, affect ability to pay shareholders dividend |
| Define "capital & reserves" | money invested from firm, originally owners, shareholders (share capital), -> retained profit | (blank) |
| advantages distadvantages "break even analysis" | 1. easy visual decision making tool, 2. cheap, 3. show how change in price influence profit, | Cons: 1. assumes all output is sold, 2. at the same price, 3. same procuts, 4. efectiveness of break even depends on quality of data |
| to what extend give current ratios the full information about a businesses financial position? | Pros:1. give indication of business liquidity, 2. other sourced i.e. Directors Report, cash flow forecast, share price, market trends, should be used to obtain financial information | Cons: 1. have to be suported by other liquidity ratios (i.e quick asset), 2. only analyise short.term liquidity, 3. profitability and efficiency ratios are required to analyse firms long-term liquidity, 4. ratios themselves only give limited picture |
| Explain the importance of profit in the financial management for a company? | profit is difference between revenue and expenses, 1. which is obtained by seeling products, | 1. important because shareholders/stakeholders need to be satisfied, 2. to be reinvested for expansion, or market research , R&D etc. |
| to which extent is budgeting important to a firms financial management? | 1. provides forecasts/plans, 2. used for sales, labour, capital expenditure, 3. budgeting itself does NOT cut costs or increase sales, 5. forms part of overall approach to fin. management | Budgeting likely features:1. profit forecast, 2. manufacturing costs, 3. employing costs, 4. R&D, 5, advertising, 6. distribution network |
| Capital Expenditure | puchase/improvements of fixed assets | appears on balance sheet |
| Revenue Expenditure | buying property, equipment, vehicles, i.e. raw materials for sandwiches, wages/salaries | is shown on P&L account |
| What does a weak liquidity position mean for a firm? | firm cld be overtrading/short of liquidity funds->can affect survivial, short-term debts, (i.e. tax and dividend payments->if not->closure), interest payments, overdraft | cld be due to expansion(increase in fixed assets), financed by debenture issues?, lack of data, misleading, "snapshot", quality?of workforce, non-financ. info? |
| What are the use and limitations of break-even analysis? | TR = TC, contribution, break.even point and margin of safety are established, 1. cheap and quick techn., 2. managers decision making, 3. can cope with changing circumstances, 4. with pricing for instance | 5. depends on accurate data, 6. difficult if more than one product involved, 7. other factors, i.e. competitors price, 7. depend on market, 8. single price!!?, 9. assumption of linearity |
| Cash Flow | movement of cash into and out of a business, inflow resutls from sales of products, whilst outflow is caused by purchases of items such as raw materials, components and labour services. | (blank) |
| Cash Flow Forecasts | state the inflow and outflows of cash that the managers of a business expect over some future period. | (blank) |
| Cash Flow | movement of cash into and out of a business, inflow resutls from sales of products, whilst outflow is caused by purchases of items such as raw materials, components and labour services. | (blank) |
| Cash Flow Forecasts | state the inflow and outflows of cash that the managers of a business expect over some future period. | (blank) |
| Forecasting | expected inflows and outflows of cash, managers can identify periods when business may experience cash problems, allows appropriate actions to be taken. , careful management of cash is a major part of effective financial management. | (blank) |
| Ratio Analysis Definition | technique for analysing a businesses financial performance by comparing one piece of accoutning information with another | (blank) |
| Internal users of Ratios | Managers, Employees, Shareholders | (blank) |
| External users of Ratios | Creditors , Governement (tax liability), Competitors, | (blank) |
| Purpose of Liquidity Ratios | assess ability of business to pay its immediate debts | 1. Current Ratio, 2. Acid Test Ration (=Quick Ratio) |
| Purpose of Efficiency Ratio | provide evidence on how well managers have controlled business | 1. Asset turnover ratio, 2. Stock turnover ratio, 3. debtors days ratio |
| Purpose of Profitability Ratio | provide fundamental measure of the success of business | 1. Net Profit Margin, 2. Gross Profit Margin, 3. Return on Capital Employed |
| Purpose of Gearing Rations | assess the extent to which the business is base on borrowed money it is a financial measure | Long-term liabilities / Capital Employed |
| Asset Turnover Ratio | Sales (turnover) / net assets firm with high sales and few assets (supermarket, pret a manger?), might have high ATR and earn low profit on each sale | measures efficiency with which businesses uses their assets, increasing means->firm operates with greater efficiency a firm can improve its ATR by improving sales performance and disposing of any surplus of underutilised assets |
| How can Gearing Ratio be improved? | by repaying long-term loans, issuing more ordinary shares or redeeming debentures | (blank) |
| Stock Turnover Ratio | (cost of sales) / stock measures firms ability to convert stock into sales. stock is always valued at costs, only relevant in manufacturing business | Sandwhich makers should be expected to sell entire stock every 2 or 3 days (freshness) |
| Debtors Collecting period Ratio | (debtors x 365) / turnover shorter figure is preferred, specially for pret-a-manger (cash sales!), however can be important marketing strategy to offer credit! | may be improved by 1. reducing credit period 2. insisting on cash payment |
| Capital employed | total funds invested in a business including that provided by shareholders and through long-term loans | (blank) |
| Gross Profit Margin | (Gross Profit x 100)/ turnover earned before direct costs (administration expenses etc) are deducted. Sandwich makers with rapid stock turnover should be able to trade with low gross profit margins | Ratio can be improved by 1. increasing prices (->lower turnover?) 2. reducing direct costs (raw materials, wages etc. ) |
| Return on Capital Employed | (operating profit x 100) / capital employed should be between 20-30%, allows assesment of overall financial performance of business. | important to compare with previos results!and competitors! Improve by: 1. increasing operating profit without raising further capital employed 2. repaying some long-term liabilities |
| Dividends per share | total dividends / no of issued shares | (blank) |
| Net Profit Margin | (Net Profit x 100) / turnover | comparison between gross & net profit margin can be informative. declining NPM comared to GPM may be due to failing to control indirect costs, i.e. purchase of new premises. |
| Ratio Analysis Limitations | 1. need to be compared with other data, previous years -> ident. trend!,firms in same and other industries. 2. Ratios only consider financial aspect of firm 3. the market (competetive, low profits etc) should be considered 4. position of firm in market | 5. quality of workforce and management team 6. economic enviroment also have to be considered to come to a valid conclusion! |
| Ratio Analysis Benefits | (blank) | (blank) |
| Operating Profit | measure of profit which a firm earns on its normal operations and EXCLUDING any extraordinary or exceptional items, which might distort a true appreciation of its usuall business. | therefore clear comparisons whith previos years or similar firms may be made |
| Profit and Loss Account short Definition | 1. is an INCOME statement, 2. shows calculation of PROFIT, 3. info from EXPENSES and REVENUE accounts | (blank) |
| Balance Sheet short definition | 1. shows NET ASSETS and CAPITAL EMPLOYED, 2. summarise FINANCIAL POSITION, 3. info from ASSET and LIABILITY accounts | (blank) |
| Costs->P&L / Balance Sheet | p&l->Expenses (i.e. petrol use for car is deducted from profit) | Balance Sheet ->Asset -> Fixed (over 12 months) or Current (bleow 12 months) |
| Total Costs | Fixed Costs + Variable Costs | (blank) |
| Profit Functions | 1. motivator, 2. allocation of resources, 3. measure of performance | (blank) |
| Taxation and Dividends | in Balance Sheet->not paid immediately -> under Current Liabilities | (blank) |
| Current Liabilities include | Tax and Dividends | (blank) |
| Depreciation in p&l + balance sheet | shown under expenses and is always the same amount by which fixed assets are depreciated in that years balance sheet | (blank) |
| Capital expenditure affects balance sheet or p&l? | Balance sheet!->cash decreases as fixed assets increase | it does NOT directly affect the p&l account (->only through depreciation->spreading costs) |
| Revenue expenditure on Balance Sheet/P&L Account: | all other costs than Capital expenditure: Balance Sheet: | P & L account: charged in full-> against sales revenue as Expenses (i.e. wages, materials etc. ) |
| Short term sources of fund | 1. bank overdraft, 2. extending creditors, 3. leasing, 4. debt factoring | (blank) |
| Sources of long-term funds | 1. internal (selling fixed assets, stock, debtors, + dividends/retained profit | external:1. debt, 2. Equity, 3. venture capital |
| Budgets usually involve: | 1. sales forecasts, 2. forecast costs, 3. cash flow forecast | + because forces managers to think ahead->avoid problems happening |
| Full Costing | allocates indirect costs as a percentage of direct costs | (blank) |
| Marginal Costing | allocates variable costs only and decisions are made on the basis of contribution | Contribution is: (selling price)/(Variable Costs) |
| Balance Sheet Definition | statement of assets and liabilities of a firm at a particular point in time->which is BALANCED! (->asset employed, capital employed) | (blank) |
| Net Current Assets | Current Assets - Current Liabilities=>Working Capital | ->should be greater than 1 ->otherwise firm will run out of cash since it will owe more than it possesses. |
| Net Assets | Total Assets - Current Liabilities | or Fixed Assets + Net Current Assets |
| Shareholders Funds | also called: Capital and Reserves->include: 1. Share Capital, 2. Reserves ( | (blank) |
| Earning per Share Ratio | (Profit after Tax) / (No of Shares) | (blank) |
| P/E Ratio | Price/Earning Ratio->(Market Price)/(Earnings per Share) | have to be compared between firms->trend->indicator of confidence in the future |
| WHAT FACTORS AFFECT THE CHOICE OF SOURCE OF FINANCE? | 1. Cost->o Source which are less expensive are preferred, both in terms of interest payments and administrative costs, 2.Use of funds->Short or long-term, 3. Status and size->Sole trader (small) are limited in their choice, PLC’s have wider choice, | 4. Financial situation, 5. Gearing->o A highly geared company may choose to issue more shares, rather than increasing interest to be paid on loans |
Created by:
1sabelle