Business Unit 3 Notes

Business Unit 3 Notes
Unit 3.1: Sources of Finance
Capital expenditure:
Capital expenditure refers to business spending on fixed assets or capital equipment of a

business. It is regarded as expenditure on the long-term investment of an organization.
Examples includes expenditure on:
● Buildings
● Tools
● Computers
● Machinery
● Vehicles
● Research and development
Revenue expenditure:
Refers to business spending on its everyday and regular operations. These expenses have to
be paid in order to keep the business operational. Examples include expenditure on:
● Stocks of raw materials, components (semi-finished goods) and finished goods which as
ready for sale, paid to suppliers
● Delivery costs
● Utility bills (e.g. gas, electricity, water and telephone bills)
● Wages and salaries to employees
● Rental payments for the premises
● Monthly repayments on bank loans and mortgages
● Insurance premiums (for example, insurance cover for buildings, employee safety and
vehicles).
Cash + debtors + stock
Total revenue - total expenses

External sources of finance:
Equity Finance - In
for offering equity finance, the provider will demand ownership of part of the company. Equity
finance does not have to be repaid, and no interest is charged. However, the opportunity cost to
the business of accepting equity finance is a loss of control and a loss of future dividends
Share capital:
This is money that is raised through the issue of shares. This option is only available to
companies and corporations. To raise capital, a business will sell shares to new investors.
Corporations will do this by issuing shares on the stock market. Anyone, if they want to, can
purchase a firm's shares via the stock exchange.
Venture Capitalists and Business Angels:
Business angels are private individuals who risk their money. Venture capitalists are companies
that use the money from their clients to fund investments. The long-term aim for a venture
capitalist is to help the company grow so they can later sell their stake for an increased price.
Debt Finance - Debt finance is money that is borrowed from a bank or other financial institution.
The borrowed money is available quickly so can fund investments. However, when money is
borrowed, interest must be paid to the lender, and can be defined as the cost of borrowing or
the reward for saving.
Loan Capital:
A loan is a medium or long-term (depending on the nature of the loan and the business) source
of finance, typically used to buy fixed assets. Mortgages are a special type of long-term loan,
lasting 20 or 30 years, used to purchase land or buildings. Traditional bank loans are usually
considered medium-term loans, and are used to purchase capital equipment. The key
advantage of a loan is that money is available immediately for investments, but is only repaid in

small chunks, over a period of years. This allows firms to use loans to buy profit-generating
assets, such as trucks or machines, now and pay for them with the revenue they generate.
Overdrafts:
An overdraft can be thought of as a high-cost, short-term loan. An overdraft is attached to a

bank account. It allows the account holder to withdraw an amount of money that is greater than
they currently hold. This must be arranged in advance with the bank, will be for a fixed amount,
and is often a service provided with a privilege bank account (i.e. long term customers or fee-
paying bank accounts).
Credit Cards:
Businesses will often use credit cards to finance small purchases needed for business purposes
on short notice. A credit card allows you to borrow money, and either pay it back next month
(and you won't pay interest), or pay it back over time and when you can (for an interest charge).
Financial aid - Money that is invested in a business with almost no opportunity cost. It does not
need to be repaid and there is no loss of ownership. Financial aid generally comes from
governments or NGOs who want to support local businesses.
Subsidies:
Subsidies are designed to increase production of goods that are deemed beneficial to society.
Subsidies are usually provided by governments. For example, a government may wish to
increase food production while reducing the price consumers pay for their meals.
Grants:

A grant is like a loan, but with no interest, that does not need to be paid back. Governments
may offer grants to businesses that are in a position to help the wider community. For example,
if a company relocates to an area of high unemployment, then the government may offer it a
grant if it employs a certain number of new staff.
Other external sources of finance - Our final three sources of finance are equally as important
as those above. However, they do not fully fit into any of the three top categories.
Trade credit:
When using trade credit, a company will obtain goods and services from a supplier immediately,
but pay for them at a later date. This is usually for a term of 30, 60 or 90 days. No interest is
charged during this credit period; it is just normal business practice for suppliers to offer trade
credit to their regular customers. Using trade credit allows a business time to sell the goods and
services they produce, and then use that revenue to pay their suppliers.
Leasing:
Rather than buying a fixed asset (such as equipment, machinery, vehicles or premises), a
business could choose to lease (hire) the asset over an agreed period of time. The key
advantage of leasing is that a company can have the benefit of using an asset without having to
raise the finance to pay for it up front. However, it does not own the asset. Therefore, if it wishes
to carry on using the asset, it must continue to pay the leasing fee. An additional benefit of
leasing equipment and not owning it is that the company can always lease and then return the
latest model. It will subsequently not need to pay for maintenance or storage of the equipment.

Short-term finance:
Short-term sources of finance are those that are repaid within 12 months. These are normally
used to solve cash flow problems or to pay for revenue expenditure.
Medium-term finance:
This refers to finance that lasts longer than one year, but less than five years. The most
commonly used medium-term source of finance is a bank loan. This would normally be used to
finance capital expenditure or to purchase a fixed asset. Leasing and subsidies can also be
classified as medium-term sources of finance, if they are used for an extended period of time.
Long-term finance:
These are long-term financial products that will be used for longer than five years. All forms of
equity finance are considered in this category. In fact, equity finance is essentially never-ending.
Once the new shareholder has made their investment and acquired ownership, they are entitled
to a share of the dividends every time they are paid. Mortgages are also considered long-term
sources of finance. These loans, used to buy property, are typically repaid over a period of 25
years.
Unit 3.2: Costs and revenues
Fixed costs - Costs that do not vary when the output changes.

Eg: Rent of building, insurance, loan repayments, leasing, salaries, advertising, equipment
Variable costs - Costs that do vary when the output changes.
Eg: Raw materials, delivery costs, packaging, commission for sales staff
Semi-variable costs - Costs that have fixed and variable components.
Eg: Production Staff, electricity, mobile phone bill
Direct costs - costs that are clearly related to the output or sale of specific good or services.
Eg: Shop employees, goods sold, store overheads, storemaintaince
Indirect costs - costs which are not clearly related to the output or sale of specific goods or
services (also known as overhead costs).
Eg: The head office, national advertising campaigns, salaries of the board of directors, KT and
infrastructure costs.
Revenue:
Total revenue = Price x Quantity
Types of revenue:
- Sale of goods and services
- Rental income
- Sale of fixed assets
- Dividends
- Interest
- Donations
- Grants and subsidies
Unit 3.3: Break-Even Analysis

Dan Bowen is a sole trader who sells digital cameras directly to consumers. He owns an
online business and all sales are processed electronically under the business name
Dan Electro.
Dan forecasts selling 700

cameras in 2012.
(a) Define the term variable costs.

[2 marks]
A variable cost is a corporate

expense that changes in
proportion to production output.
(b) (i) Construct a fully labelled

break-even chart for Dan Electro
for 2012. Calculate and indicate
the break-even point and the
margin of safety and calculate the forecasted profit from the sale of 700 cameras (show
all your working). [6 marks]
250 (price per camera) - 200 (Variable cost per camera) = 50 (contribution per unit)
30,000 (fixed costs) divided by 50 = 600 (Break even point)
Times 2 the break even point = (the max value for the x-axis)
Selling price times maximum x axis output = (maximum y axis output)
700 (Predicted output) - 600 (break even point) = 100 (margin of safety)
100 (Margin of safety times) x 50 (contribution per unit) = 5000 (forecasted profit)
(ii) Calculate the number of cameras Dan Electro must sell in order to double
the forecasted profit (show all your working). [2 marks]

600 (break even point) + 200 (doubled margin of safety) = 800
Unit 3.4: Profit and Loss Sheet:
P&L Format:
Sales revenue - Costs of goods sold
Gross profit - expenses
Net profit - interest
Net profit after interest before tax - Tax
Net profit after interest after tax - dividends = Retained profit

Balance Sheet:
Key terms:
- Balance sheet: a snapshot of the financial position of a business which is used to

determine its net worth.
- Assets: Resources of value that are owned by a business. They can be current assets or
fixed assets.
- Fixed assets: long-term assets (possessions) of an organization with a monetary value but
are not intended for resale within the next twelve months. Eg: buildings, equipment,
machinery and vehicles. The value of most fixed assets fall in value over time due to
depreciation
- Current assets: Possessions of an organization with a monetary value, but intended to be

liquidated (turned into cash) within twelve months. These include cash (in hand and at the
bank), debtors, and stocks (inventory).
- Current liabilities: the short-term debts of a business, which need to be repaid within twelve
months. Typical examples include bank overdrafts, trade creditors, short-term loans, and any
outstanding tax payments.
- Liability: These are a business's debts or what it owes to other organizations. Long or
short term liabilities.
Eg: Short term: has to be paid back in less than a year, long term more than a year.
- Equity: The money that shareholders have invested in the business plus retained profit.
- Debtor: Individuals or organizations that owe money to the business (debtors are an
asset).
- Creditor: Individuals or organizations that a business owes money to. (creditors are a
liability).

Asset + liability +Shareholders equity
Balance Sheet Order:

Fixed Assets
- Accumulated depreciation
- Net fixed assets
Current Assets
- Cash
- Debtors
- Stock
- Total current assets
Current liabilities:
- Overdraft
- Creditors
- Short term loans
- Total current liabilities
Net current assets (working capital)
Total assets less current liabilities
Long term liabilities
Net assets
Financed by:
- Share capital
- Retained profit
Equity
Balance sheets:


Depreciation:
Calculating depreciation using the straight line method:
- Annual depreciation = Purchase cost – Residual value useful lifespan
- To calculate the depreciation rate using the reducing balance method, the following
formula is applied to each year in question:
- Depreciation = Net book value × Depreciation rate
Key terms:
- Book value: The up to date value of the fixed assets (after depreciation) on the
balance sheet at the end of each year.
- Residual value: Also known as “scrap value”. This is the value of an asset at the
end of its production life.
- Depreciation: Refers to a reduction in the value of a fixed asset over time.
- Historical costs: This refers to the original price of the asset when it was first
purchased.
GROSS PROFIT MARGIN (GPM) – a profitability indicator
Definition GPM shows the percentage of sales revenue that is turned into gross profit.
Formula Gross profit margin = gross profit/sales revenue X 100
Calculate the GPM for the following business: WORKING
Example

How to improve the GPM of a business?
Raising revenue by:

- Reducing the selling price of products that have many substitutes
- Raising the selling price of products that have few substitutes
- Marketing strategies to raise sales revenue
- Seeking alternative revenue streams to boost sales.
Reducing COGS by:

- cutting direct labour costs like reducing staffing costs by cutting number of staff
- Cutting material costs like cheaper supplies and cheaper materials.
What is a good profit margin?
The higher the gross profit margin the better performing that company is.
It depends on the business and the nature of the business

- Supermarkets have a low profit margin but turn over a large number of products.
- Luxury car dealerships have a high profit margin but only turn over a small number of
products.
How to improve the NPM of a business?
Raising revenue by:

- Reducing the selling price of products that have many substitutes
- Raising the selling price of products that have few substitutes
- Marketing strategies to raise sales revenue
- Seeking alternative revenue streams to boost sales.

Reducing COGS by:
- cutting direct labour costs like reducing staffing costs by cutting number of staff
- Cutting material costs like cheaper supplies and cheaper materials.
What is a good profit margin?
The higher the gross profit margin the better performing that company is.
It depends on the business and the nature of the business

- Supermarkets have a low profit margin but turn over a large number of products.
- Luxury car dealerships have a high profit margin but only turn over a small number of
products.
Decrease expenses:
Over 15% too high
Cash Flow Forecast:
A prediction of inflows and outflows of money over a period of time. It is expressed as a financial
document.
Opening balance - the amount of cash a business has at the beginning of the month.
Closing balance - the amount of cash a business has at the end of the month
Closing balance = Opening balance + Net cash flow
Cash Inflow - money flowing into the business from sales, debtor, and other activities (eg. sale
of assets).
Cash outflow - amount of cash paid out by the business for core operations such as raw
materials and creditors.
Net cash flow - the difference between cash inflows and outflows (can be positive or negative)
Net cash flow = cash inflows – cash outflows
Cumulative Cash Flow = Previous year cumulative - following year net cash flow

Financial Item Cash inflow Revenue
Cash sales made to customer
Credit sales made to

customer
Capital raised from share

sales
Charge rent on flat upstairs
Take out 20,000 bank loan
Carry out a sale and

leaseback
Working capital - the money a business has to pay off day to day expenses. Current assets -
current liabilities
Working capital cycle - the period of time between payment for goods supplied to a business
and the business receiving cash for their sale.
Reasons for poor cash flow:
- Seasonal demand
- Poor credit collection
- Overstocking
- Poor pricing strategy
- High expenses
Purpose of Cash Flow Forecasting:

- Identify cash flow shortages
- Help make investment decisions
- Apply for finance
Why do profitable businesses fail?

- Poor collection of funds
- Paying suppliers too early
- Overtrading
- Lack of start up capital

Increasing cash inflows:
- Effective debt collection
- Cash transactions only
- Increased promotion
- Expanding product portfolio
Reducing Cash outflow:

- Better stock management
- Renegotiate credit terms
- Switch to cheaper suppliers
- Reduce expenses
- Leasing rather than purchase of equipment
How to raise more finance:

- Overdrafts
- Sale and leaseback
- Selling off fixed assets (unused)
- Debt factoring
- Government assistance
Limitations of Cash Flow Forecasting:

- Economic changes
- Increased competition
- Social changes
- Operational difficulties
- Workforce problems
Activity 1 - Creating a cash flow forecast
● Bob Brown has set up his own lemonade stall

● Produce a cash flow forecast to predict if Bob will have any cash flow problems in the first 3
months running his stall
June July August
Cash In
Sales 1,500 1,500
Total Cash Inflow 1,000 1,500 2,250

Cash Out
Banner & Table 500 0 0
Lemons & Water 200 300 450
Sugar 500 0 0
Total Cash Outflow 1,200 300 450
Net Cash Flow 200 1,200 1,800
Opening Balance 0 200 1,000
Closing Balance 200 2000 2,800
Bob’s Information:
● Bob’s opening balance is £0

● To start-up Bob needs to buy a table and a banner costing £500
● Bob believes he will make £1000 in the June (1000 units at £1)
● He then predicts sales will increase by 50% each month as people will want more Lemonade
as it gets hot
● Bob buys a 3-month supply of sugar for £500 in June
● The other ingredients are lemons and water which he buys every month: £200 in June, £300
in July and £450 in August
Activity 2 – complete the cash flow forecast

Find the values of the letters in the cash flow forecast above:
200
(a)
800
(b)
800
(c)
3,000
(d)
(e)
Payback period:
Extra Cash Inflow Required
--------------------------------------------------- X 12 months
Annual Cash flow in the Following Year

1.
Year Cash inflow Cash outflow Net Cash Flow Cumulative Net
Flow
0 $0 $200,000 -$200,000 -$200,000
1 $80,000 $20,000 $60,000 -$140,000
2 $140,000 $60,000 $80,000 -$60,000
3 $240,000 $120,000 $120,000 $60,000
4 $360,000 $200,000 $160,000 $220,000
2.
Year Cash inflow Cash outflow Net Cash Flow Cumulative Net
Flow
0 0 $450,000 -$450,000 -$450,000
1 $200,000 $100,000 $100,000 -$350,000
2 $250,000 $85,000 $165,000 -$185,000

3 $300,000 $100,000 $200,000 $15,000
4 $350,000 $100,000 $250,000 $235,000
5 $100,000 $50,000 $50,000 $185,000
185,000
------------ x 12
200,000
Investment appraisal method 2 – Average rate of return (ARR)

The ARR measures the profitability of a particular investment over time. It measures the return
on an investment as a percentage of original cost (capital cost).
The average rate of return is also known as the accounting rate of return.
It can be calculated using the following formula:
Practice Question 1:
A new machine costs a firm $500,000. The table below shows the forecasted revenues the
machine will generate over the next 4 years when it will be replaced.

Year Revenue ($)
1 200,000
2 250,000
3 280,000
4 260,000
Calculate the ARR (show all working) and comment on the results.
990,000 - 500,000/4
---------------------------- x 100 = 24.5%
500,000
Practice question 2:
A company has invested $3,000,000 in a factory in China. The table below shows the forecasted
revenues the factory will generate over the next 8 years.
Year Revenue ($)

1 250,000
2 350,000
3 700,000
4 1,200,000
5 1,000,000
6 300,000
7 100,000
8 50,000
Calculate the ARR (show all working) and comment on the results.
3,950,000 - 3,000,000/8
---------------------------------- X 100 = 3.95
-3,000,000

Extension Activity:
Year Net Cash Flows ($) Cumulative Net Flow
0 -40,000 -40,000
1 15,000 -25,000
2 30,000 5,000
3 10,000 15,000
4 5,000 20,000
Highlighted for payback period
1. Payback period: 25,000

---------- x 12 = 1 year and 10 months
30,000
2. ARR:
60,000 - 40,000/4
------------------------ x 100 = 12.5%
40,000
Year Net Cash Flow Cumulative Net Cash Flow Cumulative

Project A Net flow (A) Project B Net Flow (B)
0 (140,000) -140,000 (150,000) -150,000
1 80,000 -60,000 60,000 -90,000
2 60,000 0 60,000 -30,000
3 20,000 20,000 60,000 30,000

Highlighted for ARR
Project A

--------- x 12 = 2 years
60,000
2. ARR: 160,000 - 140,000/3

--------------------------- x 100 = 4.7
140,000
Project B

---------- x 12 = 2 years and 6 months
60,000
2. ARR: 180,000 - 150,000/3

-------------------------- x 100 =
150,000
Net Present Value:
- Net present value (NPV)

Calculator the current values of a business’s future cash flows
- Discount tables
Are used to calculate NPV (and they will be provided to you in the exams)
- If the NPV is positive/high
The investment is worth investing.
- If the NPV is negative/low
The investment is not worth undertaking.

Limitations:
- It is complicated
- Future cash flows predicted
- Discounted factors are predictions
- Discount factors could change year by year (eg: 4% in year 1, 1.6% in year 2)
Example:
A business is considering buying a new factory for $1 000 000. It will provide the following
returns over its 5-year life:
Period Net Cash Flow ($) Discount Factor Present Value ($)
Year 1 220,000 0.9434 207,548
Year 2 220,000 0.8900 195,800
Year 3 220,000 0.8396 184,712
Year 4 220,000 0.7921 174,262
Year 5 220,000 0.7473 164,406
TOTAL 1,100,000 926,728
minus initial -73272

investment cost
Net Present Value -73272

(NPV)
Practice question (from the 2013 HL exam):

a) Calculate the net present value using a discount rate of 8%. Investment cost $24m.
(2 marks)
Period Net Cash Flow ($m) Discount Factor Present Value ($m)
Year 1 2,000,000 0.9259 1,851,800
Year 2 5,000,000 0.8573 4,286,500
Year 3 9,000,000 0.7938 7,144,200
Year 4 12,000,000 0.7350 8,820,000
Year 5 17,000,000 0.6806 11,570,200
TOTAL 33,672,700
minus initial 33,672,700 -

investment cost 24,000,000
Net Present Value 9,672,700

(NPV)
The business is expected to have a positive net present value as you can see in the graph. The
NPV is 9,672,000 so it is the profit they are earning after 5 years of the investment which is 24
million.
Cash Flow Practice:
1. Define

a) Loan Finance - A loan is the lending of money by one or more individuals,
organizations, or other entities to other individuals, organizations. It is an external
source of finance and requires interest to be paid back
b) Liquidity - how quickly a business can convert its assets into cash. Non cash
assets in this context are stock, equipment, and money owed by debtors.
2.
3.
Months Cash inflow Cash outflow Net Cash Flow Cumulative Net
Flow
0 0 $7,000
1 $20,000 $12,500
2 $20,000 $,500
3 $20,000 $52,500
4 $40,000 $23,500
5 $40,000 $23,500
6 $40,000 $23,500
Payback period: 12,500

-------- x 12 months = 4 years and 2 months
23,00
ARR: 49,500 - 182,500/6

-------------------------- x 100 =
182,500
3.

a) Coffee Call can reduce cash outflow by switching to cheaper suppliers as they
pay 50% of their sales on material costs. Leasing rather than purchasing
equipment can be beneficial for the first few years till they can generate more
income.
b) Increasing cash inflow can be done by collecting the money owed to Coffee Call
by debtors and making the transaction in cash so it is a lot faster and easier to
use to expand the business in other areas.
c) If Coffee Call is looking for more finance they can sell fixed assets that are not
used anymore and can get an overdraft from the bank. Which allows an account
holder to withdraw more money than they have and it can be a high cost loan
that is usually given to long term customers and fee paying bank account.
Liquidity ratios
● Liquidity ratios measure the ability of a business to pay off its short term debts as they fall
due
A business that can pay off its debt as they fall is called solvent
A business that cantt pay it off its called insolvent
● Key terms:
o liquidity : Refers to a business ability to convert its short term assets into cash

o liquid asset are those assets that can be quickly converted into cash (cash, stock,
debtors)
o current assets: assets that are expected to to be converted to cash within a year
o current liabilities: debts due to be paid to creditors within 12 months
● The two main ratios used to assess the liquidity of a business are identified below:
CURRENT RATIO – a liquidity indicator
the ratio compares a firm's current assets to its current liabilities to determine its
Definition ability to meet its short term debt/liabilities
current ratio = current assets / current liabilities

Formula OMAR PUSSY
Calculate the current ratio for XYZ Ltd: WORKING
Example

this means for every 1$ of current liabilities, the business has 2$ of current assets
which it can use to pay off these debts
Commenting on the ratio The results should also be compared to: past performance, competitors,
recommended/safe level
it is generally agreed that an acceptable result for the current ratio ranges from
1.5:1 to 2:1
What is a good current Below 1:1 meanest he business does not have enough current assets to pay off its
ratio? current liabilities
A very high current ratio (over 3:1) might be bad too. It could mean that there is too
much cash or stock being held
reduce current liabilities and choose long - term loans instead
sell some fixed assets to generate cash

How to improve the
current ratio of a business?
ACID-TEST / QUICK RATIO – a liquidity indicator
acid - test (quick) Ratio

Definition The acid test is a stricter indicator of a firms ability to meet its short term debts as it
removes stock from the current asset. This is done because it is never certain that
stock will be sold and turned into cash
current assets - stock / current liabilities.
Formula
Calculate the acid-test ratio for XYZ Ltd: WORKING

Example
this means for every $1 of current liabilities, the business has $0.78 of current assets
(less stock) which it can use to pay off these debts
Commenting on the ratio
it is generally accepted that the acid - test ratio should be at least 1:1
below 1:1 means the business does not have enough current assets to pay off its
What is a good acid-test current liabilities
ratio?
A high acid test ratio might be bad too. It could mean that the business is holding
too much cash that could be invested to generate profit.
reduce current liabilities ( bank overdrafts) and choose long-term loans instead
How to improve the acid- sell off unused fixed assets as this will increase the level of cash in the business
test ratio of a business?
sell of stock at a discounted price - this will convert stock into cash which will help
improve the acid test ratio.

Efficiency Ratios:
Efficiency Definition Formula Exam What is a How to improve the

Ratios ple good efficiency ratio
example
Gearing Indicates how much Loan capital (B&S) Above 50% -Increase retained profit
ratio of the capital ---------------------- x 100 is high, (instead of returning it as
employed is made Capital employed (B&S) below 25% dividends).
up of long term is low
loans (compared to Loan capital = retained -Issue more shares to
equity) earnings plus equity increase equity.
-Repay long term loans.
Capital employed =
Retained earnings + long
term debt.
Creditor Measures the Creditors 15 Lower the -Develop good

days ratio average number of ------------- x 365 days better as relationships with
days it takes for a COGS debts are suppliers as they may be
business to pay its repaid extended.
debts to quickly and
suppliers/creditors there is no - Improve stock control to
risk of bad reduce creditor payment.
credit
rating.
30-60 days

Debtor Measures the Debtors 15 Normal - Do background check
days ratio average number of ------------------- x 365 days credit before offering credit to
days it takes for a Sales revenue period is customers
business to pay its 30 days
debts to - Penalties for late
suppliers/creditors. payment.
- Offer incentives to
encourage early payment.
Stock Measures how Number of days: No. Lower the -Decrease prices to clear
Turnover quickly a business Average stock/COGS x 365 Days: better as stock.
ratio sells it stock 60 stock is -Increase promotion
Average stock = opening days cleared
stock - closing stock/2 quickly - Change product mix:
No. of remove items that don't
Number of times: times: sell/
COGS/Average stock 6
times
per
year
Case study
How efficient is Coca-Cola?
Coca-Cola is one of the world's biggest brands. According to Forbes, in 2017,

Coca-Cola ranked the world's fifth biggest brands. But how financially efficient is
it?
Data: ($ 000)

Retained earnings plus equity 5,554,000
Inventory 2,902,000
Cost of goods sold 17,482,000
Sales revenue 44,294,000
Debtors 3,941,000
Creditors 9,991,000
Long-term debt 28,407,000
1. Use the data above to calculate:
a. Stock turnover ratio

Number of days:
2,902,000/17,482,000 x 365 = 61 days
Number of times:
17,482,000/2,902,000 = 6 times
b. Debtor days
3,941,000/44,294,000 x 365 = 32 days

c. Creditor days
9,991,000/17,482,000 x 365 = 209 days
d. Gearing ratio
28,407,000/33,961,000 x 100 = 83%
2. Comment on the company's efficiency with reference to the commonly

established benchmarks.
Coca Cola has a very high creditor day ratio as it takes 209 days out of 365 for Coca
Cola to buy back its suppliers. This doesn't develop good relationships with suppliers
and the suppliers might decide to not provide them with resources in the future. The
gearing ratio is at 83%, which means they are significantly in debt causing its ability to
make interest payments and to cover operating expenses. Coca Cola’s stock turnover
ratio is not the best because 60 days is too long for Coca Cola to sell its stock. This
indicates the business is not running well and they need to offer some discounts or
develop their products in order to sell its stocks faster. A preferable ratio is between 30
to 40 days which indicates the business is operating well as people are buying their
products. The second ratio of stock turnover is the number of times Coca Cola sells its
stock in a year and it is 6 times per year which is also very low. Coca Cola can improve
this by lowering its prices by offering discounts or developing their products in order to
sell their stocks faster and more frequently.
Investment Appraisal Practice:

Year Location A Cum CF Location B Cum CF
0 (12,000) -12,000 (12,000) -12,000
1 3,000 -9,000 6,000 -6,000
2 4,000 -5,000 5,000 -1,000
3 5,000 0 3,000 2,000
4 6,000 6,000 2,000 4,000
5 5,000 11,000 5,000 9,000
Payback period A: 3 years
Payback period B: 1,000/3,000 x 12 = 2 years and 4 months
ARR - A: 11,000/5
------------------------ x 100 = 18.3%
12,000
ARR - B: 9,000/5
--------------- x 100 = 15 %
12,000
Net Present Value:
- 10%
Period Net Cash Flow ($m) Discount Factor Present Value ($m)
Year 1 3,000 0.9091 2,727

Year 2 4,000 0.8264 3,305
Year 3 5,000 0.7513 3,756.5
Year 4 6,000 0.6830 4,098
Year 5 5,000 0.6209 3,104
TOTAL 16,990
minus initial 16,990 - 12,000

investment cost
Net Present Value 4,990

(NPV)
Budgets:
A budget is a financial plan of expected revenue or expenditure for a period of time in the future.
Budgets can be for a whole business collectively or for individual departments.
● What are some of the key things included on a budget?

- Sales
- Fixed and variable cost
- Direct and indirect wcost
● Outline TWO different ways of setting a budget.
- Zero based budget: Departments bid for how much they need for the year. If they can
justify their spending, they will be awarded the budget they asked for.
- Based on Previous Years: Use last year's figures as a base and modify.

● Which final account is a budget most similar to? (circle one)
o Profit and loss account
o Balance sheet
● Identify 4 key differences between a budget and a profit and loss account.
1. Budget: Forecast, P&L: Summary of the previous 12 months
2. Budget: Internal planning documents, P&L: companies are legally obliged to publish
3. Budget: Any part of the business, P&L: all revenues and costs from the entire business.
4. Budget: Time frame varies, P&L: Records all transactions for an entire year.
Variances
● Define the term variance analysis.
A variance is the difference between the actual outcomes and the budgeting outcomes.
● Briefly outline what each of the following types of variances mean:

Type of variance Meaning
Means the variance is beneficial to the business
Favourable variance
Is when the variance is detrimental the business

Adverse variance
Actual outcome = Budget outcome (the business budgets well)

No variance
Variance = Actual outcome - Budget outcome

● Complete the simple variance activities below:
Variance/Sales: 2,000
Variance/Wages: 1,000
Actual Figure/Raw materials: 14,000
Budget Figure/Rent: 6,000 (f)
Actual Figure/Sales: 95,000

Budget Figure/COS: 40,000
Expenses: Budget Figure: 35,000, Actual figure: 25,000 (A)
Net profit: Budget Figure: 25,000, Variance: -15,000 (A)
Extension activity – Practice questions

Examine the budget and complete the questions below:
Sales revenue - 100 (A)

Direct labour costs - 5 (F)
Direct material cost - 10 (A)
Gross profit - 105 (A)
Overheads - 5 (F))
Net profit - 100 (A)
1. Complete the variance column in the table above and indicate whether the results are
adverse or favourable.
2. Comment on the performance of the business using the variance results.
3. To what extent are profit and cost centres important for businesses
Cost centres and profit centres

● Define the term cost centre.
Areas of the business that do not generate any income
● Define the term profit centre.

An area of the business that generates revenue
● With reference to the example of a school, provide examples of cost centres and profit
centres.
Profit centre:
- Slices
- Uniform company
- Bus drivers
- Teachers
Cost centres:
- Cleaners
- IT
- Security
● Businesses can often be divided into cost centres and profit centres in the following ways:
o by department: examples include finance, production, marketing, and HR, where
each department is a specific cost centre.
o by product: a business producing several products could ensure that each product is
a cost centre. For example, Samsung produces mobile phones, televisions,
computers, and many more products. Each of these products could be cost centres
because costs are measured in their production.

o by geographical location: businesses such as the McDonald's Corporation or Coca-
Cola Company are located in different parts of the world and each of the areas they
are located in could be treated as cost centres.
● What is the purpose of establishing cost centres and profit centres? How do they help a
business?
- Determines level of performance expected. If it is a profit centre it has more pressure to
perform than a cost centre.
● Are the following parts of a large, international hotel cost centres or profit centres? (tick the
correct one).
Part of the business (hotel) Cost centre Profit centre

Spa x
Maintenance team x
Restaurant x
Accounting department x
Concierge selling tour packages x
Gym x
Key Finance Formulas:
Concept Description Formula
Working capital Working capital relates to the Working capital = current assets – current liabilities
(net current short-term cash (net current assets)
assets)
Net assets Net assets refers to the value Net assets = Total Assets - total liabilities
of a business’s assets after all
of its liabilities have been
subtracted.

Total costs Variable Costs + Fixed Costs
Equity (Owners equity) Total assets - Total liabilities
Total Assets Fixed assets + Current assets
Net current assets Currents assets - current liabilities
Total Current assets Cash + Debtors + Stock
Total Variable Costs Variable Costs per unit * Quantity sold
Total liabilities Current liabilities + Long term liabilities
Current Assets
Net profit
Net profit before

Gross profit - expenses
interest and tax
Current Liabilities Overdraft + creditors + short term loans
Contribution per unit

Selling Price - Variable Costs per unit
(CPU)

Net profit after interest and tax -
Retained Profit
Dividends
Break-even point Fixed Cost / Contribution per unit
Margin of safety Current Output - Break Even output
Capital employed Total assets- total liabilities
Profit Total Revenue - Total Costs
Opening Stock + Purchases - Closing

Cost of Goods Sold Stock
(COGS)
Sales revenue - Gross profit
Net Gross Margin Net profit before tax - sales revenue
Gross profit margin Gross profit/Revenue
Gross profit Sales revenue - COGS
Net profit before tax / sales revenue x

Net profit margin
100
Net Cash Flow Cash inflows - cash outflows
Previous year cumulative - following year

Cumulative Cash Flow
net cash flow
Closing balance Opening balance + Net cash flow
Variance Actual outcome - Budget outcome
Depreciation: Straight (Purchase cost – Residual value) /

line method (per year) Expected lifespan of asset
Depreciation: Reducing

Plan for 2&4 Mark Question:
2 marks:
- Point
- Apply (elaborate on the question)
4 marks:
- Define key terms
- Point (only if its in the case study)
- Explain (always link back) x2
- Apply
Plan for 10 Mark-Question:
Introduction:
- Opening sentence/introduce business
- Definition of key concept
- Thesis statement
- What the response will examine
Body 1:
- Topic sentence
- 1st advantage (with link/evidence from stimulus and explanation)
- 2nd advantage (with link/evidence from stimulus and explanation)
- Closing statement
Body 2:
- Topic sentence
- 1st advantage (with link/evidence from stimulus and explanation)
- 2nd advantage (with link/evidence from stimulus and explanation)

- Closing statement
Conclusion:
- Clear judgment which relates back to the question and your thesis statement.
- Use of long term v short term framework to shape/develop your judgement.
- Use of different stakeholder (stakeholders, suppliers, employs, consumers) perspectives
to shape/develop your judgement.
- Use of financial v non financial framework to shape/develop your judgement
- Concluding statement (potentially refer back to the business.

Business Unit 3 Notes

Uploaded by

Copyright:

Available Formats

Business Unit 3 Notes

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Business Unit 3 Notes

Uploaded by

Copyright:

Available Formats

Business Unit 3 Notes

Unit 3.1: Sources of Finance

Capital expenditure refers to business spending on fixed assets or capital equipment of a

Cash + debtors + stock

Total revenue - total expenses

Venture Capitalists and Business Angels:

Cash + debtors + stock

Total revenue - total expenses

An overdraft can be thought of as a high-cost, short-term loan. An overdraft is attached to a

Cash + debtors + stock

Total revenue - total expenses

Cash + debtors + stock

Total revenue - total expenses

Unit 3.2: Costs and revenues

Cash + debtors + stock

Total revenue - total expenses

Variable costs - Costs that do vary when the output changes.

Semi-variable costs - Costs that have fixed and variable components.

Eg: Production Staff, electricity, mobile phone bill

Eg: Shop employees, goods sold, store overheads, storemaintaince

Total revenue = Price x Quantity

Unit 3.3: Break-Even Analysis

Cash + debtors + stock

Total revenue - total expenses

Dan forecasts selling 700

(a) Define the term variable costs.

A variable cost is a corporate

(b) (i) Construct a fully labelled

30,000 (fixed costs) divided by 50 = 600 (Break even point)

Selling price times maximum x axis output = (maximum y axis output)

Cash + debtors + stock

Total revenue - total expenses

Unit 3.4: Profit and Loss Sheet:

Sales revenue - Costs of goods sold

Gross profit - expenses

Net profit - interest

Net profit after interest before tax - Tax

Net profit after interest after tax - dividends = Retained profit

Cash + debtors + stock

Total revenue - total expenses

- Balance sheet: a snapshot of the financial position of a business which is used to

- Current assets: Possessions of an organization with a monetary value, but intended to be

Cash + debtors + stock

Total revenue - total expenses

Balance Sheet Order:

Net current assets (working capital)

Total assets less current liabilities

Long term liabilities

Cash + debtors + stock

Total revenue - total expenses

Total revenue - total expenses

Calculating depreciation using the straight line method:

- Annual depreciation = Purchase cost – Residual value useful lifespan

GROSS PROFIT MARGIN (GPM) – a profitability indicator

Formula Gross profit margin = gross profit/sales revenue X 100

Calculate the GPM for the following business: WORKING

Cash + debtors + stock

Total revenue - total expenses

Raising revenue by:

Reducing COGS by: