IGCSE Bs Std Sect 5

Financial Information & Decisions

Ch 22 - Business Finance

Finance
Finance Departments
- Recording all financial transactions [eg payments]
- Preparing Final Accounts
- Producing accounting information for managers
- Help make important financial decisions [eg source of finance to use]

Why Business Need Finance

- Finance = Money / Capital
- Need money to purchase goods & services [expenses]
- Capital Expenditure = Money spent on non-current assets [eg buildings]
-
- Revenue Expenditure = Money spent on day to day expenses [eg wages]
- Ex why Finance is needed:
a. Starting Up business
i. Start-Up Capital = Finance needed by new business to pay for
essential and current assets a begin trade

b. Expansion of business
i. Increase profits

c. Additional working capital

i. Working Capital = Finance needed by business to pay day to day cost

Sources of Finance
- Internal [within] or External [outside business] sources
- Short Term or Long Term sources (only applicable to external sources of finance)

Internal Finance
1. Retained Profit
- Profit business obtains after costs and dividends to shareholders
- Adv:
a. Does not have to be repaid
b. No interest to pay, raised within business
- Disadv
a. New business will not have any
b. Small firms profit may be low to finance expansion
c. Reduces payment to owners [dividends for shareholders]

2. Sale of Existing Assets

- Sales of existing assets which are no longer use to business
- Eg; surplus equipment
- Adv:
a. Better use of Capital tied up in business
b. Doesn’t increase debts of business

- Disadv:
a. Take time to sell assets, might sell at a lost
b. Not available for new businesses

3. Sale of Inventories
- Selling finished goods, spare parts and other inventory items
- Adv:
a. Reduces opportunity cost
b. Reduces storage cost

- Disadv:
a. May disappoint customers if sudden change in demand is not met

4. Owners Savings
- Sole trader / members of business put more of savings into company
- Adv:
a. Quick availability
b. No interest is paid

- Disadv:
a. Savings may be low
b. Increases risks for owners, unlimited liability

External Finance
1. Issue of Shares
- Sale of business shares, limited companies only
- Adv
a. Permanent source of capital
b. No interest
c. Doesn’t need to be paid back

- Disadv
a. Dividends [% company earnings] paid after tax
b. Shareholders expect dividends
c. Ownership will change if many shares are sold
2. Bank Loans
- Sum of money from a bank repaid with interest over a certain period of time
- Adv
a. Quick, easy to arrange
b. Available for varying lengths of time
c. Large companies receive low interest rates, if huge sum of loan

- Disadv
a. Must be repaid with interest
b. Collateral / security must be given → bank has right to sell some property if
fails to payback loan

3. Selling Debentures
- long term loans stretching over 10 years, offered by limited companies
- Debentures = Certificate issued to debenture holder for money lent, which must be
repaid usually within 20-25 years
- Adv:
a. Long term finance

- Disadv
a. Loans must be repaid, and interest must be paid

4. Debt Factoring
- Specialist agencies that buy claims of debtors of forms for immediate cash
(third party gets involved, they make a profit by collecting original sum of money from
debtor, sort of like loan sharks)
- Debtors = Customer who owes business money for goods
- Adv:
a. Availability of immediate cash
b. Risk of collecting becomes the debt factors, not business

- Disadv:
a. Firm doesn’t receive 100% amount

5. Grants and Subsidies

- Grants money given from outside agencies [eg govt]
- Adv:
a. Don’t have to be repaid

- Disadv:
a. Company must comply by certain rules and regulations made
6. Microfinance
- Providing financial services to poor people not served by traditional banking (very
small amounts are provided. Eg : $70 to buy a sewing machine for sewing business)
- Banks usually don’t give loans to poor people → Only need few dollars and don’t
have assets for security
- Adv:
a. Small loans can be obtained by startups

- Disadv:
a. High-interest rates
b. Greater risk for lender

7. Crowdfunding
- Funding a project or venture by raising money from numerous people who each
contribute a relatively small amount (they are not stakeholders or shareholders or
investors)
- Usually done through internet
- Adv:
a. Fast way to raise decent sum
b. No initial fees are payable, only when a goal is reached a % will be taken
c. Allows public opinion to be heard if idea is good

- Disadv:
a. Crowdfunding platforms may reject proposal if not done well
b. If total amount is not raised, money invested by others will have to be repaid
c. Media interest and publicity needed to work well

Short - Term Finance

Provides working capital needed by businesses for day to day operations

1. Overdrafts
- Arranged by a bank (bank allows business to draw more money than the business
has in their account)
- Adv:
a. Flexible form of borrowing
b. Interest will be paid only in the amount overdrawn
c. Business allowed to overdraw [spend more money than in current account]

- Disadv
a. Interest rates are variable, not fixed interest rate
b. Bank can ask for overdraft to be paid at very short notice
2. Trade Credit
- When businesses delay payments to suppliers
- Adv:
a. Almost interest free loan
b. Reduces cash outflow in short run
- Disadv:
a. Suppliers refuse to give discounts or supply any goods if not paid

3. Debt Factoring
- Specialist agencies that buy claims of debtors of forms for immediate cash
- Debtors = Customer who owes business money for goods
- Adv:
a. Availability of immediate cash
b. Risk of collecting debt becomes the debt factorer, not business

- Disadv:
a. Firm doesn’t receive 100% amount

Long - Term Finance

- Finance options available for more than a year
- Eg; Used to purchase long term fixed asset

1. Bank Loans
- Sum of money from a bank repaid with interest
- Adv
a. Quick, easy to arrange
b. Available for varying lengths of time
c. Large companies receive low interest rates, if huge sum of loan

- Disadv
a. Must be repaid with interest
b. Collateral / security must be given → bank has right to sell some property if
fails to payback loan

2. Hire Purchase
- Allows business to buy fixed asset over long period with monthly interest payments
(the product the business is paying for is not under the business’s name until the full
amount has been paid)
- Adv:
a. Doesn’t have to find large cash sum to purchase asset

- Disadv:
a. Cash deposit paid at start of month
b. High-interest rates
3. Leasing
- Allows firm to use asset without paying for it (the asset is under the leasers name
entirely and cannot be bought)
- Leaseback : when a company sells its assets then leases it back to reduce expense.
- Adv:
a. Doesn’t have to find large cash sum to purchase asset
b. Maintenance of asset taken care by leasing company

- Disadv:
a. Total cost of leasing charges will be higher than purchase
4. Selling Debentures
- Long term certificates issued by limited companies ( loans stretching over 10 years or
more)
- Debentures = Certificate issued to debenture holder for money lent, which must be
repaid usually within 20-25 years
- Adv:
b. Long term finance

- Disadv
b. Loans must be repaid, and interest must be paid

Long term loans or Debt Finance

- Difference from share capital
- Loan interest paid before tax and is expense
- Must be repaid with interests
- Often secured against particular assets

Factors when Choosing Source of Finance

- Main factors in financial choice. Businesses use these criterias when choosing a
financial source to run their business.
1. Size of Business & Legal Form ( what type of business the company is [pvt
Ltd)
- Limited companies have larger choice of sources of finance, pay less
interest [less risk]
2. Amount of Capital Required
- If need little money → Won't issue new shares

3. Purpose of Capital & Time Period

- Finance source match financial need
- If use of capital long term → source should be long term [vice versa]

4. Risk and gearing (Existing Loans)

- If a business has high amount of debt, (often represented in
percentage gearing amounts) about 50% or more - the bank will not
issue loan due to the high risk

5. Control = Owners may lose control of business if keeps giving up shares

Banks & Their Loans
- Why banks refuse to loan to small businesses
a. Weak Cash flow
b. Lack of assets for security
c. Poor preparation by business owner when applying

- Banks need these to loan:

a. Cashflow forecast [why it's needed and how it will be used]
b. Business Plan
c. Assets for security
d. Forecast income statement [show chances of business making profit]

- Shareholders likelihood to invest

1. Company share price increasing
2. Dividends are high [% of earnings]
3. Company has good rep and plans for future growth

[CHAPTER END]
Ch 23 - Cash Flow Forecast

Cash Flows
- Cash = Liquid Asset, immediately available for spending on goods and services
- Cash flow = Flow of money into and out of business in a period
a. Inflow → Money received by business
b. Outflow → Money coming into business

- Inflow methods:
1. Sale of goods
2. Sale of assets
3. Payments by debtors
4. Borrowing money
5. investors

- Outflow methods:
1. Purchase of goods
2. Purchase of non-current assets
3. Payments of salaries
4. Repaying loans

Cash Flow Cycle

- Shows stages between paying out cash and receiving cash in business
- Cash flow Cycle:
1. Cash outflow
2. Pay for materials, rent,etc
3. Goods Produced
4. Goods Sold
5. Cash payment received for goods sold [cash inflow]

- Uses:
1. Longer time for cash flow cycle to be finished → greater working capital
2. Understand importance of planning for cash flows

- Cash flow is NOT profit

- Profit → goods sold on credit / Cash flow → Business Cash Sales in a month
- Insolvency → When profitable business run out of cash
a. Long credit time
b. Expanding too quickly and keeping high inventory level [overtrading]
c. Purchase of too many fixed assets
d. Long credit time for customers
Cash Flow Forecast
- Cash Flow Forecast = Estimate of business future cash inflows and outflows on
monthly basis also shows expected cash balance
- Forecast Table Ex:

1. Opening Cash Balance → Amount business holds at start of month

2. Closing cash balance → Amount business holds at end of month
3. Cash inflow → Money going into business
4. Cash outflow → Money going out business
5. Net cash flow → Diff between cash inflow and outflow [inflow - outflow]

- Uses
1. Starting up Business
a. First few crucial months to business as owners don’t realise amount of
cash needed
b. Many expenses → labour, land, capital, promotion
c. Owners don’t understand importance of cash flow in business hence
fail
d. Cash flow forecast can avoid this

2. Keeping Bank Manager informed

a. Cash flow forecast help business receive loan→ Bank manager needs
to know amount needed, duration and when repaid
b. How much cash available for expenses and investment opportunities
c. Whether business is holding too much cash

3. Managing an existing Business

a. Can be used for loans incase of running out of cash
b. Forecast used for information needed before loaning [same as before]
c. Needs to be planned in advance
4. Managing cash flow
a. Business with very high bank balance can use their cash more
effectively in other areas
b. Forecast informs if business is holding too much cash

Cash Flow Problems

- Short Term Sol
1. Increasing bank loans
a. Inject more cash into business
b. Interest and loan must be paid [reduce profits, cash outflow]

2. Delaying payments to suppliers

a. Decrease cash outflows in short run
b. Suppliers may refuse to provide discounts or supply if not paid on time

3. Reducing credit periods

a. Help Business increase short-term cash inflows
b. Customers may switch to competitors which offers this

4. Delaying purchase of fixed assets

a. Reduce cash outflows temporarily
b. In long run, company may lack efficiency → don’t have updated
technology and facilities

- Long Term Sol

1. Attracting New Investors
2. Cutting costs and increasing efficiency
3. Develop new products to attract customers

Working Capital
- Capital readily available to a business to pay for everyday expenses in short run
- Working capital = Current assets - current liabilities
- Can be in forms of
a. Cash
b. Value of Debtors
c. Value of inventory
- Should be handled properly → shows investors / banks how efficient a business is
and financial strength [credit rep]

[CHAPTER END]
Ch 24 - Income Statements

Accounts
- Terms:
1. Accounts = Financial records of a firm’s transactions
2. Accountants = Professional qualified people who are responsible for keeping
accurate accounts and producing final account
3. Final Accounts = Produced at end of financial year → give detail about
profit/loss and worth over the year
- Profit = Sales revenue - Total Costs
- Increase profits:
a. Increasing sales revenue
b. Reducing production costs
c. Doing both

Importance of Profits
- Important to private sectors
1. Reward for Enterprise
a. Successful entrepreneurs have many important qualities → rewarded
for it
2. Reward for Risk-Taking
a. Anyone who provides capital take risks [shareholders,etc] → profit
reward those risks
b. Payment act as incentives to invest more and make business
profitable
3. Source of Finance
a. Profits after payment can be used to fund expansion
4. Indicator of Success
a. Profits shows investing can be profitable, but losses show investment
shouldn’t be made
b. Profit is NOT cash → Profit derived from revenue only → Cash can be
achieved from many places

- Importance to public sectors

1. Used as source of finance to develop state-owned business or be more
efficient

- Importance to social enterprise

1. Balance profit-making with their aims, profit used for firm’s survival
Understanding Income Statements
- Income Statement = Financial statement that records income of business and all
costs used to earn that income over period
- Managers, banks and others will use it to see if business is making profit
a. To compare with previous years
b. To compare to competitors

- Main Features
1. Revenue
a. Income to a business from sales of goods and services
b. Units sold x Price per unit

2. Costs of Sales
a. Cost of production or buying the goods the business sells during a
period
b. Opening Inventories [remains] + Purchases - Closing Inventories

3. Gross Profit
a. Profit made in revenue is greater than than cost of sales
b. Calculated before fixed costs are considered
c. Revenue - Cost of Sales

4. Trading Account = Shows how gross profit is calculated

5. Net Profit
a. Profit business makes after deducting all costs
b. Gross Profit - Fixed Costs
c. Depreciation = Fall in value of fixed assets overtime

6. Retained Profit
a. Net Profit after counting taxes and payments to owners [profit left]
b. Reinvested into business-
- Dividends & Corp Tax → Only for limited companies
- Ex:
- Uses
a. Know profit/loss made
b. Compare performances
c. Profitability of individual products
d. Which products to launch

[CHAPTER END]

Ch 25 - Statement of Financial Position

Statement of Financial Position

- Statement of Financial Position = Document that shows value of business assets and
liabilities at a time
- Assets = Items of value owned by business
a. Current Assets = Items owned by business less than 1 year, eg raw material
b. Non-Current Assets = Items owned by business more than 1 year, eg building

- Liabilities = Debts owed by business

a. Current Liabilities
i. Debts owed by business for less than 1 year, eg wages

b. Non-current Liabilities
i. Debts owed by business for more than 1 year, eg loans

c. Total Equity
i. How much a business is worth
ii. Shareholders Funds / total equity = Total Assets - Total Liabilities
iii. Funds → Money invested in business by shareholder/owners
iv. Money can be invested in share capital [shares] or reserves [retained
profit]
v. If total equity increase/fall, shareholder’s stake will be worth more/less
- Ex:
Interpreting
- Shareholders can see value of their stake
- Can analyse how expansion has been paid for by long term loans, retained profit or
increase share capital
- Calculate working capital
a. Working capital = Current assets - current liabilities

- Calculate capital employed = Long term & permanent capital invested into business
a. Capital employed = Shareholder’s funds + Non current liabilities

[CHAPTER END]

Ch 26 - Analysis of Accounts
Analysis of Accounts
- Analysis of Accounts = Using data in accounts to make useful observations about
performance and financial strength of business
- Informs:
a. Comparisons with business last year
b. Comparisons with competition

Profitability and Liquidity

● Profitability: Assesses how effectively a business generates profit. Key for

comparing performance over time and against competitors.
● Liquidity: Measures the ability to meet short-term debts. Critical for financial stability;
a lack of liquidity can disrupt operations even if profitable.

Liquidity Ratios

● Current Ratio: Shows if a company can cover its short-term liabilities with current
assets.
○ Formula:

○ Ideal Range: 1.5 to 2.

● Acid Test Ratio: A stricter measure, excluding inventory, to assess quick liquidity.
○ Formula:

○ Ideal Value: Generally above 1.

Profitability Ratios

● Gross Profit Margin: Shows profitability from sales after the cost of goods sold,
indicating production efficiency.
○

● Net Profit / Profit Margin: Reflects overall profitability after all expenses are
deducted.

● Return on Capital Employed (ROCE): Measures how effectively capital is used to

generate profit.

Why and How Accounts are Used

● Purpose: Accounts are analysed to assess performance, identify trends, and make
comparisons with industry standards.
● Usefulness: Enables stakeholders to make informed decisions, evaluate profitability,
and judge financial stability.
Users of Accounts

● Managers: Use accounts for strategic decision-making and operational control to

improve the business
a. Keep control of performance of division of businesses
b. Identify which part of business performing well
c. Help in decision making

● Shareholders: Assess profitability to determine returns on investment.

a. Higher profitability ratio compared to last year → More likely to keep investing
b. Do not want to invest in company with cash problem

● Creditors: Review liquidity ratios to assess repayment ability.

a. Determine if company able to pay back debts on time
b. If liquidity problem → suppliers refuse to supply goods on credit

● Government and Regulatory Bodies: Ensure compliance and transparency in

financial reporting.
a. Workers → To see if future of company is secure
b. Govt → Check on profit tax paid by company
c. Competition → Compare performances with business competitors in same
sector

Limitations

● Data Access: External users can only view published accounts, which may reduce
detailed data. Only internal users can access [managers, etc]
● Historical Nature: Ratios are based on past data, which may not predict future
performance.
● Inflation and Accounting Differences: Inflation can distort figures, and different
accounting methods can lead to inconsistent comparisons between businesses.
● Different Accounting Methods: Company could use a different method in
calculating their accounts, making comparisons difficult
Calculation Formula Sheet

Chapter 23: Cash Flow Forecast

Opening cash balance → Amount business holds at start of month -

Closing cash balance → Amount business holds at end of month -

Cash inflow → Money going into business -

Cash outflow → Money going out business -

Net cash flow: Cash inflow - outflow Inflow - Outflow

Working capital = Current assets - current liabilities [debt,etc] Assets - Liabilities

Chapter 24: Income Statements

Cost of Sales = Opening Inventories [remains] + Purchases - Closing Remaining
Inventories inventory +
Purchases -
Inventory left

Profit: Total Revenue - Total Cost Revenue + TC

Gross Profit = Revenue - Cost of Sales Revenue - Cost of

sale

Net Profit = Gross Profit - Fixed Costs GP - FC

Retained Profit = Net profit - All other expenses [eg; taxes] NP - all other
expense

Revenue: No. products sold x price per product No. products sold
x Price

Chapter 25: Income Statements

Shareholders Funds [Total equity] = Total Assets - Total Liabilities Asset - liability

Capital employed = Shareholder’s funds + Non current liabilities Funds + Non

current liability

Chapter 26: Analysis of Accounts

Profitability Ratios: -

Gross Profit Margin = Gross Profit / Revenue x 100 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡

𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑥 100
Net Profit Margin / Profit Margin = Net Profit / Revenue x 100 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝑥 100

Return on Capital Employed [ROCE] = Net Profit / Capital Employed x 100 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑥 100
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑

Liquidity Ratios: -

Current Ratio = Current Assets / Current liabilities 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Acid Test Ratio = Current assets - Inventories / Current liabilities 𝐶. 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠