Unit 5 – pg 1 CIE – Business Studies

Unit 5 – Financial Information and Decisions

5.1 Business finance: needs and sources

“Money to a business is like blood is to the human body. Without it, the other party cannot function.”

“Finance is the language of business.”

Businesses always need capital:

Purpose Capital Classification Forms of expenditure
To start-up business Venture capital Money spent on starting up the business – eg. Purchase of
fixed assets, materials or any business and license fees.
To expand an existing Fixed capital Capital expenditure (CAPEX): money spent on fixed assets
business Money invested in which will last more than one year – eg. Building, vehicle,
non-current assets and equipment.
[long-term finance]
To increase finance for Working capital Revenue expenditure / Operating expenditure: money
day-to-day activities Money invested in spent on day-to-day operations or running costs - eg.
current assets wages, raw materials, and electric bills.
[short-term finance]

Vocabulary:
Venture Capital – funding for business start-ups and small businesses with exceptional growth potential.

Working Capital – money (cash or non-current assets that can be sold quickly) available to the business for
carrying out its day-to-day activities.

Fixed Capital – money invested in non-current assets with long productive lives.

Current assets - assets that can be easily sold to turn into cash and used up by a business within the next 12
months to make payments.

Non-current assets (or fixed assets) – long-lived assets that remain productive for more than one year.

Short-term finance – funds available to a business for up to a year – it covers financing needs for a small
period and/or repayment takes less than a year. It is usually needed due to uneven flow of cash in working
capital.

Long-term finance – funds available to a business over many years – it covers financing needs for a lon period
and/or repayment takes more than a year. It is usually needed for fixed capital.
Unit 5 – pg 2 CIE – Business Studies

Sources of finance can be:

• Internal or External. Internal source is obtained from within the business itself and external source is
obtained from sources outside of and separate from the business
• Long-term or Short-term

The tables in the following pages 3 and 4 summarize the mains sources of finance and their advantages and
disadvantages. The tables do not cover debentures – read about them in page 367.

Alternative sources of finance - Microfinance and Crowdfunding

Microfinance: ________________________________________________________________________________

Crowdfunding: _______________________________________________________________________________

Advantages of crowdfunding Disadvantages of crowdfunding

Sources of finance: How business makes the choice

With so many sources of finance to choose from, a business has to carefully select the appropriate one.

Purpose and time period:

Amount needed:

Legal form and size:

Control:

Risk and gearing – does the business already have loans?:

Unit 5 – pg 3 CIE – Business Studies
Unit 5 – pg 4 CIE – Business Studies

External sources of finance can provide capital in the form of debt (repayable loans) or equity (non-repayable capital).
Unit 5 – pg 5 CIE – Business Studies

Unit 5.2 - Cash Flow Forecasting & Working Capital

Cash flow (def): the flow of money into and out of a business is called cash flow.

Cash in flow examples: __________________________________________________________________________

Cash out flow examples: _________________________________________________________________________

1. cash
needed to
pay for

5. cash 2. raw
payment materials,
received for wages, rent,
goods sold etc.

3. goods
4. goods sold
produced

Figure 1. Typical cash flow cycle in a business

Vocabulary:
Overheads – regular monthly expenditures to keep the business running (e.g. rent, salaries, bills)
Insolvent – inability to pay debts
Cash flow forecast- prediction of expected income and expenses of a business in near future and shows
expected cash balance at the end of each month.
Liquidity/ liquid assets – assets that can be easily sold to turn into cash.

Cash flow & Profit

- Not the same.
- Businesses can go on without a profit for some time, provided it has enough cash.
- But if a business run out of cash, it’ll collapse. Business entering insolvency state.
- Several reasons why this can happen.
o Customers taking too long to pay back on purchases. By the time they pay, business is out of cash.
o Purchasing too many assets at once.
o Producing too much stock/inventory. Overtrading.
o Borrowing too much.

Working Capital – capital needed to finance the day to day running expenses and pay short term debts.
Business needs enough cash to keep trading in the short term.
Working Capital = Current assets – Current liabilities.
Unit 5 – pg 6 CIE – Business Studies

Net cash flow – the differences between total cash inflow and total cash outflow.
Closing bank balance = Opening bank balance + Net cash flow

Key components of a typical cash flow forecast of a used car showroom. 2000L is the initial investment. Each car
sells for 300L.

Month / lakhs 0 1 2 3 4 5 6 7 8 9

Opening balance 2000 500 700 600 500 700 0 -100 100 0

Total cash inflow 0 300 0 0 300 0 0 300 0 0

Total cash outflow 1500 100 100 100 100 700 100 100 100 100

Net cashflow -1500 200 -100 -100 200 -700 -100 200 -100 -100

Closing balance 500 700 600 500 700 0 -100 100 0 -100

 Cash flow is important! It can send a business into insolvency and ultimately into bankruptcy.
 Cash flow doesn’t take into account how the money is spent or where the income is from.
 With cash flow forecast, business management can predict when the business may need cash infusion and
plan for it accordingly.

How can you overcome short-term cash flow problems?

Methods Limitations

How can you solve cash flow problems in the long-term?

Unit 5 – pg 7 CIE – Business Studies

Unit 5.3 – Income Statements

Yearly statement/ accounts. Shown in comparison with previous year’s data. Also known as Income Statement or
Profit and Loss Statement.

Main features of an Income statement:

o Revenue _______________________________________________________________________________

o Cost of Sales / Cost of Good Sold ____________________________________________________________

o Gross Profit _____________________________________________________________________________

o Expenses / Admin & General Expenses _______________________________________________________

o Operating Profit _________________________________________________________________________

o Finance cost ____________________________________________________________________________

o Profit before tax _________________________________________________________________________

o Tax ____________________________________________________________________________________

o Profit after tax / Net Profit _________________________________________________________________

o Retained Profit __________________________________________________________________________

o Dividend / Profit for distribution ____________________________________________________________

How is Statement of Comprehensive Income used in business and decision making?

 For Investment decisions

 Cost Analysis
 Future Forecasts
 Business target/goal setting
 Comparison on performance (comparing last year / industry average / competitors)

Nature and importance of Profit

 Reward for risk taking

 Profit is necessary for growth – source of fund for reinvestment
 Measure of business performance – indicator of success
 Motivation (but not everyone is profit focused)
Unit 5 – pg 8 CIE – Business Studies

Unit 5.4 – Balance Sheet

Also known as statement of financial position. Businesses keep track of all resources they own and what they owe
to others (banks, debtors, suppliers) and the business owners.

Assets = Liabilities + Equity (capital)

Features of a Balance Sheet / Statement of Financial Position

Non-current assets are aka Fixed Assets.

These are assets that last for more than one year. These are the most productive assets of a business. For example,
machinery and equipment to produce goods, land & buildings to house all the machinery in, long term investments a
business has made. They would all last for more than a year. Goodwill is also a non-current asset.

Current assets

They are likely to be changed into cash within a year. Example include, cash, Inventories (these would be goods
inside a 24 hour mini-mart, that can be sold easily to turn into cash), Trade receivables (money that you will soon get
from the business customers).

The liquidity of an asset is how quickly it can be turned into cash.

Current liabilities

Liabilities / debts that have to be repaid within a year.

For example: rent, hire purchase, salaries, short term loans, overdrafts, taxes.

Non-current liabilities

Liabilities / debts that are payable after 12 months.

For example: long term debt, mortgage, long term leases, long term hire purchases agreements.

Net Current Assets

Also known as Working Capital. This shows whether a business has liquid enough assets to pay for immediate bills.

Net Current Assets = Current Assets – Current Liabilities

Working Capital = ________________________________________

Net Assets

Net Assets = Totral Assets – Total Liabilities.

Net Assets = (Non-current Assets + Current Assets) – (Non-current Liabilities + Current Liabilities)

Net Assets = Shareholders’ Equity.

Total Assets – Total Liabilities = Equity.

Capital Employed

The amount of money invested in the business.

This information is only given on a Balance Sheet. Not possible to find on the Income statement.
Unit 5 – pg 9 CIE – Business Studies

Unit 5.5 – Analysis of accounts

Why do we use it?
Good to compare one against another or one against itself the previous year.

Performance Ratios
Gross profit margin

Operating profit margin or Net Profit margin

Return on Capital Employed (ROCE) – profit of a business as a % of the total invested capital used to generate it.

Liquidity Ratios
Current Ratio

ACID test ratio or Quick ratio

Unit 5 – pg 10 CIE – Business Studies

Unit 5.5.3 – The Use of Financial Documents

We use them to assess the performance and health of a business. Just like how the doctors use the blood test to
check on our health.

Who uses these information

Internal Stakeholders – owners, shareholders, employees and managers

External Stakeholders – banks, creditors (trade payables), government, potential investors, customers

Discuss how each of these stakeholders would use the financial data.

Uses of Financial information

• Business decision making
• Investment analysis
• Increasing Profitability
• Reducing Costs
• In the UK, limited company reports are made available to the public.
• Government – policies, economic progress, research
• Competition
• Auditors
• Media
• Registrar of Companies (DICA in Myanmar) but accounts are not made public

Benefits and Limitations of financial statements and ratios

Benefits Limitations
Users can compare ratios over time Ratios and financial statements show/compare past data. Information
and identify trends about the past cannot be used to predict the future entirely. Stakeholders
are much more interested in the performance of the business in the
future.
Users can compare results with Ratios and financial statements do not include the strengths and
similar businesses to see how well a weaknesses of a business, for e.g. the quality and skills of employees.
business is doing against These factors are also likely to affect business performance, especially
competitors. profitability.
Using ratios, users can easily identify Income statements and balance sheets are not always prepared in the
important information such as same way by different businesses. Therefore, the ratios do not compare
profitability and liquidity, without like for like.
having to look at all of the financial
statements.
Businesses are affected by external factors – such as legislation, exchange
rates and economic factors – but these will not be shown in the financial
statements.
Unit 5 – pg 11 CIE – Business Studies

Unit 5 – Active Recall Questions

1. Explain two uses to stakeholders of accounting ratios.

2. State the formula used for calculating gross profit margin.
3. State the formula used for calculating profit margin.
4. State the formulaused for calculating return on capital employed.
5. State the formula used for calculating the current ratio.
6. State the formla used for calculating the acid test ratio.
7. Is profitability more important than liquidity? If not, why not?
8. Explain two limitations of accounting ratios.
9. How does balance sheet provide users with information about how a business is being financed?
10. Explain why a balance sheet prepared six months ago may not show the business’s current financial position.
11. Explain why the retained profit figure shown on a business’s most recent balance sheet may be lower than
on the previous year’s balance sheet.
12. Define the term non-current asset using an example.
13. Define the term non-current liability using an example.
14. Other than bank/cash balances, state two other current assets.
15. State two current liabilities.
16. Explain why a business wants its current assets to be greater than its current liabilities.
17. Explain the difference between gross profit and profit.
18. Explain the purpose of the appropriation account on an income statement.
19. What is meant by dividends?
20. Explain the term ‘gross profit’.
21. State three reasons why profit is important to businesses.
22. Explain why profit differs from cash.
23. Define the term ‘working capital’.
24. How is working capital calculated?
25. Why is working capital important to a business?
26. Explain why cash is important to a business.
27. Why is it important for a business to forecast its cash flow?
28. How might a business finance a short-term cash shortage?
29. Explain the difference between internal and external sources of finance.
30. Explain the main advantage of retained profit as a source of finance.
31. Identify three factors that influence the choice of finance.
32. Explain the advantages large businesses often have over small businesses when they borrow money from
banks.
33. State three reasons why businesses may need finance.
34. Outline the difference between short-term and long-term finance.