C22 FINANCE
Finance = Capital = Money
Finance (Capital): is the funds available for a
business to carry out its spending requirements
22.1 Why does a business need finance?
• Start-up capital: Capital which is needed to
buy the factors of production and inventories
so that a firm can begin trading. Finance
needed by a bz to start a business and pay for
NCA, CA, Market Research
• For Expansion: The amt needed to expand a
firm. It can be done by: additional assets,
takeover/ merger, new products, new
markets.
• Working Capital: Finance needed to meet
the day – to – day expenses of a business
(wages, suppliers, rent). If bz does not have WC
, it cannot able to pay costs then output cannot
be produced
• Product Development: high cost of
producing prototypes, cost of market research
for new product (1) there is high outflow of
cash with no inflow for a certain time til
product is launched
Two Type of Expenses
1. Capital expenditure: money spent
on non –current assets. These items
appear in the SFP and lasts more than
one year
2. Revenue expenditure: money spent
on day-to-day, recurring expenses.
These are items that will be used up in
the short run and is charged to the P/L
account as an expense
Source of Finance
1. Internal Source: obtained from within the
business itself
2. External Source: obtained from sources
outside the business
Internal External
RP Share issue
Sale of assets Debenture
Sale of inventory Grant
Owner Savings Bank Loan
Collect TR Overdraft
Leasing
Hire Purchase
Debt Factor
Micro Finance
Trade Credit
22.2 Factors in choosing SOF
(i) Size of business & Legal Form (type of
business): Public limited companies have larger
choice of sources of finance and have lower
interest rates (less risk) than unincorporated
(ii) Amount needed: if you need just a little
money you won’t issue new shares use ST SOF
(iii) Purpose: match the source to the purpose.
If use of capital is long-term, source should be
long-term. If use of capital is short-term, the
source is also short-term
(iv) Amount of Existing Loans: if a business
already took out lots of loans, banks will think it
is too risky to finance (high gearing levels)
(v) Rate of Interest: high rate will discourages
firms to take loans- cost of borrowing too high
so will more likely to issue shares
(vi) Desire of Control: business that wants to
maintain control will avoid selling shares or
getting new partners. Prefer to take loans
(vii) Credit history (k) lenders want to
know if bz has ability to repay
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22.3 Time Period of Finance
1. Short-Term Finance Needs: working
capital for day-to-day operations. Money
that must be paid back in less than a year.
Why Bz Needs Short-term Finance:
(i) To provide WC (k) – so that day-to-day
expenses can be paid for like inventory, wages
– an overdraft may be suitable as it is only used
if needed which potentially reducing interest
paid
(ii) To prevent cash-flow problem (k)
by taking short-term bank loan, the business
can improve the cash position of the
business for a short time to overcome the
potential shortage of cash and increase
liquidity
(iii) Offer credit to customers (k)
(iv) Ensure survival
2. Long-term Finance Needs: finance
available for more than a year, usually used
to purchase non-current
Short Term Long Term
• Overdraft • Issue Share
• Trade Credit • Issue Debenture
• Debt Factor • Grant
• Bank Loan
• Leasing
• Hire Purchase
• Micro Finance
Why Bz Needs Long-term Finance:
(ii) To purchase long-term non-current assets
(k) as these assets are likely to be very
expensive – so a long-term bank loan may be
suitable as it is repaid over a long period of
time reducing the amount of monthly outflows
each month
(ii) To expand the business (k) which requires a
large amount of money in order to grow – the
issue of shares will not incur interest payments
(iii) To update the business (k) often involves
new technology which is expensive – so
payments may need to be spread over a long
period of time such as with a lease
INTERNAL SOF
1. Retained Profits: Profit after tax and
dividends that is reinvested in the business.
Also known as ploughed back profits.
✓ does not have to be repaid
✓ Readily available- quick to arrange
✓ No interest to pay – do not increase
expenses
✓ no security required which a bank loan
requires
✘ New business has no/limited RP to use
✘ firms have low RP
✘ Reduces dividends to shareholders
✘ No money left for emergencies [k]
2. Owner’s savings
✓ Quick availability
✓ No need to repay – permanent capital
✓ No interest is paid
✘ Savings may be low
✘ Increase risks of owners
3. Sale of inventory
✓ Reduces opportunity cost less money tied
up as idle stock
✓ Reduces storage costs
✘ May disappoint customers if sudden if not
enough inventory is maintained
4. Sale of existing idle assets
✓ Assets not needed can be sold to
riase money - better use of unwanted
capital tied-up
✓ Does not increase debts
✘ Takes time to sell
✘ Not available for new firms- no surplus
asset to sell
✘ Asset could have been used
during expansion
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5. Ask customers to pay more quickly [k]
Reduce trade receivables or reduce time given
for customers to pay
✓ does not increase debts
✘ shorter credit time may reduce sales
✘ reduce profits (k) may need to offer
discounts to customers to encourage to pay
fast
EXTERNAL SOF
1. Overdraft (ST) – when the bank allows a
business to withdraw more money than they
have in their bank account
✓ flexible form of borrowing – varies each
month
✓ can arrange quickly
✓ OD cheaper than loans in short run
✓ interest only paid on amount overdrawn
✓ can be used for whatever purpose
✓ No security required
✓ Help avoid CF problems
✘ Variable interest rates while loans are fixed
rates
✘ Bank may ask the repayment with a short
notice
✘ High interest rate compared to bank loan
When to use OD?
• For WC need [k] when the capital need is
short term [k] as its quick to arrange [an]
• For general expenditure not a specific
purchase [k] as overdraft is flexible [an]
• No security available [k] as overdraft does not ✓ Able to spread cost [k] payments are made
need any collateral to support it
• For CF problems [K] as these are likely to be
temporary so only borrow money for time
needed [an]
• Need quick access to funds [k] as an overdraft equipment [app]
is easy to arrange [an].
2. Trade Credit (ST) – delay paying suppliers to
be in better cash position
✓ Interest free loan for time delayed
✓ Reduces cash outflows in the short run
✓ increases cash reserves (k) allows a business
to sell its products before need to pay
✘ Supplier may not provide discounts if
payment is not made quickly
✘ Affect relations with suppliers
Why New Business Cannot Get Trade Credit
• No previous experience [k]
• Seen as higher risk (k) lenders don’t trust
them and unsure if business is able to pay
• Could offer no security [k]
• Unproven product/
3. Factoring of Debts (ST): Debt factors are
specialist agencies that buy the claims on
debtors of firms for immediate cash.
✓ Immediate cash is available
✓ The risk of collecting the debtors becomes
the factors not the business
✘ Firms do not receive 100% value of debts
4. Leasing / Hiring (MT) –It allows a firm to use
an asset but doesn’t have to purchase it
✓ Do not have to find a large cash sum to
purchase the asset (k) so has funds available for
other purposes
✓ Can return asset [k]only rent when needed
✓ Maintenance is taken care by leasing
company (k) lowers operating costs
each month so do not need to find larger sum
of cash at start [an] can help with cash flow
✓ Easier to update equipment as new models
are brought in [k] does not have to buy more
✘ Total costs of leasing charger are higher than
purchasing if leased long-term, increases total
cash outflow
✘ Asset not owned [k] so will not add to value
of SFP [an] has to be returned at the end of the
lease
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 5. Hire Purchase (MT) – When a business buys
a non-current asset in monthly payments OD Loan
(which include interest) • Interest paid • Interest paid on
on amount over- amount borrowed
✓ It allows a business to buy a NCA over a long drawn • complicated-
period of time with monthly payments which • Easy to more documents
include interest arrange • Collateral
✓ Doesn’t have to find a large cash sum to • No collateral • Fixed interest
purchase the asset • Expensive – rate- Large firms
high interest can negotiate
✘ Cash deposit is paid at the start of the month rates lower rate
✘High interest rates • Appropriate • Appropriate for
for Revenue Capital Expense
6. Bank loans (MT/LT) – A sum of money Expense • Can take loan for
obtained from a bank which must be repaid • Repayable on varying length of
with interest. They are payable over a fixed demand time
time period • Variable • Fixed interest
interest rate rates
✓ Quick, easy to arrange for larger firms
✓ Large firms receive low interest rates if large
DOCS Needed to Get Bank Loan
sums are taken (EOS)
✓ Have a set time to repay 1. CFF which shows why the finance is needed
✓ Have a fixed interest rate and how it will be used.
✓ Appropriate for long-term assets 2. Income statement for the last time period –
✓ Can spread repayments over long time (k) and a forecast one for the next. These should
allows time to gain extra revenue to meet show the chances of the business making a
repayments [an] profit in future.
✓ Time to repay (k) Paid back in monthly 3. Details of existing loans and sources of
instalments over several years finance being used. (gearing levels)
✓ Banks provide all the loan amount at once 4. Business plan to explain clearly what the
✓ Does not dilute control business hopes to achieve in the
future and why the finance is important to
✘ loan must be repaid these plans.
✘ interest must be paid and is an expense.
Gearing Level: ratio of total capital financed by
interest rates are usually higher for small firms
long-term debts.
✘ Collateral/security must be given
✘ Increases debt – raise gearing-more risks LTL / Capital Employed x 100%
✘ take time to convince bank [k] as needgearing
to
produce financial documents , bz plan [app] Problems of High Debt
✘ higher interest rates for new bz or
unincorporated business ✘ High gearing and high financial risk [k] so
banks / suppliers might be reluctant to lend to
Banks refuse loans to small businesses: them [an] hard to expand
✘ Higher interest expenses [k] which will
1. Weak cash flow reduce level of profit [an]
2. Lack of security or collateral (no assets that
✘ Problems if interest rates rise [k] as might not
can be sold if the business fails)
be able to meet repayments [an] increasing risk
3. No business plan
✘ Difficult to raise additional finance [k] if
4. Low revenue-so can they afford to repay
lenders fear business not able to repay further
[an]
loans
5. Already has existing debt [k]
6. Limited experience [k] so no guarantee that ✘ CF problems - inability to pay debts back on
business will last [an] time – forced into liquidation
• Unpr 7. Unproven product [k] seen as higher risk
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7. Issue of shares (LT): Only available to Factors to Consider Before Issuing Shares
limited companies
(i) ease of selling: likelihood of shares being
✓ Permanent source of capital- do not repay taken up by the market
✓ No interest to pay
✓ Access to greater amounts of capital [k] as (ii) impact on share price [k]/ if market don’t
no restriction on shareholder numbers [an] like issue it reputation or share price [an]
✓ Does not increase debt [k]does not increase
(iii) risk of takeover [k] loss of control of existing
gearing
shareholders
✓ Less financially risk than bank loan
(iv) cost and time of issuing shares
✘ Ownership gets diluted, risk of take-over
✘ Shareholders expect dividends (v) complexity of process of issuing shares
✘ Issuing shares is time-consuming and
expensive
✘ shares may not be bought – no guarantee 8. Issue of Debentures (LT): a certificate that is
can raise planned amount issued to a debenture holder for the money
they lent which has to be repaid within a span
Shareholders are most likely to buy of 20 – 25 years.
shares when:
✓ Long term finance
(i) the company’s share price has been ✓can structure payments over long time
increasing
(ii) dividends are high – or profits are rising so ✘ Repaid with interest
dividends might increase in the future
(iii) other companies do not seem such a good
investment 9. Micro-Finance (LT)- specialist institutions
(iv) the company has a good reputation and that provide smaller loans to poorer people to
has plans for future growth. start up their own business. Micro finance is
very important in developing countries. Mostly
Information SH needed to See before banks don’t give loans to poor people because
Becoming Shareholder: loan amount too small and have no security to
give
• Profit and loss account
• SFP – value of assets, liability
✓ High interest rates
• Current ratio
✓ does not need security to obtain [an]
• Cash flow forecast
• Sales forecast
✘ Greater risk for the lender
• Break even analysis
• Share price/ recent dividend/
• Capital employed 10. Grant: sum of money from govt
• Amount of borrowing to support sustainable businesses

Loan Share ✓ Don’t have to be repaid

Interest paid Dividends paid
✓ No interest paid
Must be repaid Permanent
Increases gearing capital
✘ Given with strings attached
Require Collateral No effect on
gearing ✘ may not provide full amount
Dilutes control ✘ may have restrictions about how it is used /
No collateral cannot use the money how you want to [k]
✘ can take time to apply/obtain [k]

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11. Crowdfunding: funding a project by raising
money from a large number of people who
each contribute a relatively small amount, Purpose Source of Finance
typically via the internet. Inventory OD, ST Loan, Trade
Wages, Rent Credit
✓ No initial fees are payable to the
crowdfunding platform. Equipment LT loan, RP,
✓ Allows the public’s reaction to the new Vehicle lease, hire purchase,
business venture to be tested before product sell idle assets, grant
launch
✓ Can be a fast way to raise substantial sums Expansion LT loan
✓ Used when other ‘traditional’ sources are Premises Debenture
not available. Share Issue
✓ Not a debt so no interest to pay and does
not have to be repaid

✘ Platform charges a percentage fee if

finance raised
✘ Crowdfunding platforms may reject an
entrepreneur’s proposal if it is not well
thought out.
✘ If the total amount required is not raised,
the finance that has been promised
will have to be repaid.
✘ Media interest and publicity need to be
generated to increase the chance of
success.
✘ Publicizing the new business idea or product
on the crowdfunding platform could allow
competitors to ‘steal’ the idea and reach the
market first with a similar product.

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 C23 CASH FLOW

23.1 CASH FLOW and PROFITS Profit: surplus that remains after all costs have
been subtracted from sales
Cash flow of a business is the cash inflows and
outflows over a period of time. Profits = Total revenue – total cost

Cash inflow – money coming into the business Cash is a Liquid Asset – it can be immediately
available to spend on goods & services
Cash Outflow: money going out of the business
Profit is NOT SAME as NCF because:
Cash inflow Cash Outflow
Cash Sale of goods Purchase of good 1. Credit Sales increases Profit when goods
Cash Sale of NCA Purchase of NCA are sold and is shown in the IS in the
Payments by TR Payment TP month of sale, but it does not involve
Take Bank loans Repaying loan cash movements so will not be shown in
Investors Funds Investors Withdraw the CF till actual receipt of funds
Grants Payments of expenses
Interest Received Dividends Paid 2. Purchase of stock by cash is an outflow
Tax Payments and can reduce cash flow but is not
shown as revenue in IS until the goods
Net CF: difference each month between the cash are actually sold
inflow and cash outflow (NCF = Inflow – Outflow)
3. Expansion: Purchase of NCA is an outflow
Cash flow cycle: It shows the stages between but will only show improvements in IS
paying out cash and receiving cash. The longer it only in the future
takes for the cash flow cycle to be completed the
greater should be the working capital.

Stages in CF Cycle
1. Cash needed to pay for materials, wages
2. Time taken to produce goods
3. Time taken to sell goods
4. Cash received from customer

If a business does not have enough cash, it will

have major problems:

• unable to pay workers, suppliers, rent to

landlord, tax to government
• production of goods and services will stop –
workers will not work for no pay and suppliers
will not supply goods
• business cannot give credit to customers and
will go to rivals
• business may be forced into ‘liquidation’ –
selling up everything it owns to
pay its debts.

C23: Cash Flow 1

 Reasons of CFF Problems 23.2 Cash Flow Forecast

1. Overtrading/ purchase too much inventory in
anticipation of high demand
2. High level of TR (k) Giving Long credit time to
customers to increase sales which means that
cash payments are delayed and cause CF
problems
Cash Flow Statement– is a statement that shows
cash inflows (money received by business) &
outflows (money paid) over a period of time.
Cash-Flow Forecast – an estimate of future cash
inflows and outflows. A CFF shows the expected
cash balance at the end of each month

3. Not able to purchase materials on credit (k) Uses of CFF

Receiving Less credit time from suppliers which
means bz makes payments sooner ✓ Avoid CF problems (K) can predict possible
causes of cash flow problems [k] and look for
4. Paying supplier to quick to gain discounts solution in advance.

5. Expansion- purchase NCA leads to huge ✓ Help manage cash flow better (k) They show
outflows whether the business is holding too much cash or
too little. Businesses with high bank balance can
6. Poor cash management – spending too much use their cash effectively in other areas like
money; does not make CFF. paying off loans or buying NCA. If low balance,
will arrange for loan in advance or will delay
7. Seasonal or Low Demand expansion.

8. Unable to get a loan or bank overdraft ✓ To secure bank loans (k) The bank manager
needs to see CFF to be aware when the amount is
9. Increase in fixed costs such as rent needed, for how long, when it will be repaid

10. Increase in variable costs such as wages,
materials (inflation)
11. Unexpected changes (k) fall in demand due to
new rival
✓ Helps in financial planning (k) Shows how much
is spent every month and can secure finance for
it.
Formal of CFF

12. Opening cash balance is negative Month Mar Apr

Cash Inflow 500 700
Cash Outflow 350 800
Net CF 150 -100
Opening Bal 30 180
Ending Bal 180 80

Opening Bal: Amount of cash held by a business

at the start of the month /trading period

Ending Bal: Amount of cash held by a business at

the end of the month /trading period

C23: Cash Flow 2

 How Business Activities Affect CF
1. Business Closure
• Increase demand so increases inflow
• Can sell at higher prices so increases inflow
2. Increase in Minimum Wage
• Increase labor costs so more cash outflow
• No effect if already pay high wages to keep
them motivated business
3. Introduce New Technology
• initial cost to buy machinery [k] which increases
cash outflow
• reduce wages costs as few workers are needed increase cash inflows [an] but cost of advertising
(k) so less outflow (an)
• Increased training costs [k] increasing cash
outflows [an]
• Possible redundancy payments [k] increasing
cash outflow [an]
• Sell old machinery / use an external source of
finance (k) which generate a cash inflow [an]
23.3 Solving CFF Problems
1. Increasing bank loans will inject more cash
into the business but interest and loan will have
to be paid. Usually secured by a collateral
2. Use Overdraft: Immediately available and easy
to arrange but have to pay high interest and
increases cash outlow
3. Delaying payments to suppliers will delay
outflows in the short run but supplier may
refuse to provide discounts or refuse to supply
and this can halt future production and unable
to make output to generate inflow
4. Reducing credit period to customers may help
a business increase short term inflows but
customers may switch to competitors and lead to
a greater fall in inflows (an)
C23: Cash Flow
5. Offer discounts to customers or do cash sales
only (k) so business receives money faster. This
will reduce business profit margins and make
customers go to rivals leading to lower inflows
6. Delaying purchase of NC assets will reduce
outflows but in the long run a company may lack
efficiency as they don’t have updated technology
7. Sell unwanted non-current assets [k] so
releasing cash tied up in the business
8. Find cheaper supplier [k] as this would reduce
cash outflow [an] but cheaper could mean lower
quality
9. Increase number of customers [k] which could
could increase outflows in the short-term [an]
10.Reduce level of inventory [k] use of JIT so less
money is not tied up as stock (an)
Long-Term Solutions to CF Problems
1. Attracting new investors- do public issue of
shares but will dilute control, dividends are paid
2. Cutting costs and increasing efficiency using
lean production but requires workers
commitment
3. Develop new products to attract customers,
but new product development is costly and time-
consuming
3
 23.4 Working Capital
Working Capital: the capital available to a
business to pay for day-to-day expenses.
WC = CA - CL
Liquidity: business ability to pay back its short-
term debts
Importance of WC
Importance of Managing CF
Importance of Cash
Importance of Liquidity
• To pay wages to workers who make products, if
lack of WC then may not be able to pay wages-
not able to supply good as workers will not work
if not paid
• To pay suppliers/ trade payables, if lack of WC
cannot pay suppliers – refuse to supply – halt not
production - unable to satisfy customer needs –
gain poor reputation with customers as being
unreliable.
• To repay debts and interest (k) If there is
insufficient WC, banks can cease collateral
• To pay for operating expenses (light, rent) If
there is insufficient WC then it will be difficult for
business to continue trading
• To ensure business survival and continuity (k)
Failure to pay these sorts of costs will result in
the business ceasing to operate. Hence it is
crucial to survival.
• For emergency or unexpected expenses
• Prevent CF Problems (k) so does not become
insolvent
• So business can take advantage of special offers
or discounts on bulk purchases
• To ensure business has a good reputation
especially for a new business
• Know
C23: Cash Flow
Which is More Important? Cash or Profit?
Profit is the main objective of the private sector,
without it there is no point of business. It is a
measure of business success and essential for LT
survival. It is also a SOF so business can grow
without depending on loans. It is also a reward to
investor to retain investments.
However, Cash is needed to operate a business. A
business needs to manage its cash flow to make
sure it can pay day-today costs [k] such as
suppliers otherwise it might not have sufficient
materials to continue production [an]. Positive
cash flow means business is liquid and is able to
meet CL on time. A negative cash flow means
business is receiving less cash than it is
spending [k] If negative might mean business is
insolvent and can be forced into liquidation [k]
whether business makes a profit or not [an]
Evaluation: Cash is always important as day-to-
day expenses must be paid. Cash flow is more
important as a business can continue for a while
without making a profit, but will find it very
difficult to survive without cash especially at a
time when a business is growing. In the short run
a business can survive without making a profit so
cash flow is more important to the business lasts
long enough to make profits
4
 C24- 25-26
1. TR = P X Q Gross Profit – the profit made after costs of goods sold
2.COST = OS + Purchases – CS are deducted from revenue
3. GP = TR – Costs of Sales
4. GP = TR - VC Net Profit (Operating Profit) – the profit made after all
5. NP = GP – Operating Expenses expenses and overhead costs from GP
6. NP = TR-TC
7. RP= NPAT – dividends Net Loss: deficit that occurs when GP is less than
operating expenses (GP < Operating Expenses)
Accounts are the financial records of a firm’s
transactions Gross Profits Sales- COGS
TR > COGS
Accountants are professionally qualifying people
who have responsibility of keeping accurate Gross Loss TR < COGS
accounts and producing final accounts
Net Profit GP - Overhead
Final accounts are produced at the end of financial GP > Overhead
year and give details about the profit/ loss made
over the year and the worth of the business Net Loss GP < Overhead

24.1 Income Statement
Income Statement: financial document that records
the income and costs incurred over a time period.
The main features of an income statement include:
Revenue and Costs
Revenue: Income of the business during a given
period of time from the sale of goods or services
TR = Quantity sold x selling price per unit
Why is Revenue Important?
Dividends: profit after tax paid out to shareholders of
the business
High or Low Dividends??
(i) High dividends will benefit shareholders as they
receive higher rewards; however this could
lead to cash-flow problems and lower RP to
expand business
(ii) Low dividends will dissatisfy shareholders, but
means more retain profits for expansion

(i) Pay for day-to-day expenses

(ii) Measure bz success against competition Retained Profit - the net profit after taxes and
(iii) Revenue needed to generate profits payments of dividends to SH – which is reinvested back
(iv) Revenue needed to break-even into the business
(v) Steady amount of revenue can help in loan RP=NP- tax – dividends
applications.
G. Importance of RP

COGS: cost of producing or buying the goods sold (i) It is a source of funds for expansion of
business or buy non-current assets
COGS = Open Invty + Purchases – End Inventory
(ii) Can be used to pay off outstanding debts
Effect of Increase in Costs of Materials
(iii) Can be used to build up cash reserves and
1. Rise in Cost of Sales maintain liquidity
2. Fall in GP

C24-25-26 1
FORMAT OF IS Why Sales Fall?

Total Revenue (P x Q) $1000 (i) Increase in competition [k] so customers have a

wider choice of goods to pick from [app]
Cost of Sales
Opening Invty 50 (ii) Prices too high [k] so customers choose from
Purchases. 700 cheaper priced rivals [app]
Closing Invty (150) $600
Gross Profit $400 (iii) Products don’t meet needs (k) rivals sell better
Operating Expense $120 products (app)
Operating profits $280
Tax $ 28 (iv) Advertising is wrongly directed/advertising
Net Profit after tax $262 message is unappealing [k] so customers are
Dividend $150 not aware of products [app]
Retained Profit current year $112
Retained Profit previous year $488 (v) Poor quality [k] as product is not as good as
RP ending year $600 other companies [app]

Ways to Increase Profits

Uses of Income Statement
1. Increase Sales
(i) Measures business performance (k) To see if
business is making profit/loss. (i) Higher Prices if D is inelastic; high P if D is
elastic make bz less competitive and customers
(ii) IS is important in decision making in a go to rival. This will increase profit margins per
business such as location or pricing decisions unit but overall total profit is lower.

(iii) Used to support loan applications: banks (ii) Lower price when D is elastic will lead to more
want to know business performance before quantity sold higher TR and profits - make
giving loans product affordable

(iv) Show shareholders / owners how business
performed [k] owners want to know
performance to decide whether to keep or
sell share
(v) Used to measure business success (k) help
decide if the business should continue
trading [k]
(vi) Able to calculate profitability ratios: GPM,
NPM, ROCE. Used To compare with rivals (k)
see if higher than competition OR To
compare with previous years - if it is greater
than the year before, bz is a success
(iii) Advertising : increase awareness and persuade
customers to buy, thus increase sales and
profits
(iv) Sell new products appeal to more customers,
increases TR and profits
(v) Sell in new markets (export) to increase will
widen customer base and increase sales
(vi) Improve Quality: Better quality will add more
value so can sell at higher prices and have
higher sales
(vii) Loyalty schemes [k] could encourage existing
customers to buy more from him

(viii) E-commerce or sell via website [k] appeal to a

wider segment – lead to more TR

C24-25-26 2
2. Lower Costs
(i) Use cheaper supplier to reduce VC but could
mean poorer quality goods [k] so customers
might look elsewhere for goods (ap)
(ii) Buy in bulk to benefit from economies of
scale [k] reduces VC
(iii) Buy direct from manufacturer to lower costs
(iv) Replace workers with machines to reduce
VC, but does bz have finance to buy new
machines? Must pay workers redundancy
pay – increase costs (an)
(v) Sell online [k] so lower rent – lower fixed
costs
(vi) Relocate where rent is cheap – reduces FC
but could affect sales
(vii) Lean Production: JIT and Kaizen will reduce
waste, reduce AC, increase profits
(viii) Reduce Advertising: reduces FC, lowers Yes
marketing budget but less awareness
(ix) Pay Minimum Wages: keep labors costs low
(x) Employ fewer workers to reduce labor costs
No
but this could cause much stress for workers
to do more work
C24-25-26
Increase Price or Cheaper Materials to Raise Profits?
Raise Prices: High price may suggest better quality [k].
It also lowers break-even point [k] so need to sell less
to cover costs. But, if D is elastic, it could lead to fewer
customers as they buy from rivals [an] resulting in
lower revenue [an]
Cheaper Materials: Will lower the variable cost [k]
which will lower total costs / improve profit margin
[an]. Cheaper materials can lower costs, so bz can sell
cheaper and more people can afford to buy. But
buying cheaper materials can mean poor quality, affect
bz reputation (an) so customers may go to rivals.
Evaluation: This depends if D is elastic or inelastic. If
inelastic, can raise P without reduce D as much. But if
D elastic, increase in price should lead to lower
revenue [an]. Another factor to consider is the level of
competition before prices are changed
Is Reducing Costs the Best Way to Increase Profits???
Lower costs could contribute to higher contribution
per unit and profit margins. The business can be more
price competitive and sell at lower prices, thus
increasing Demand and TR.
However, lowering costs such as looking for cheaper
materials can mean poor quality so customers may go
to rivals. Lowering costs by reducing wages may affect
motivation levels. Some products are sold at higher
prices to help image of high quality. Lowering costs
can affect product image.
Evaluation: Business may also raise price to increase
profit margins. High price can help give image of high
quality and raise profits. But high price can also mean
customers can go to rivals. Lower costs can enhance
profits as long as it does not affect final product quality
or cause motivational problems among workers.
3
24.2 Profits
Profit is the surplus left over after total costs have
been subtracted from the sales revenue.
Profits = TR - TC
Importance of PROFITS
1. Profit is important for private sector
companies – main objectives
2. Reward for enterprise: Reward for risk
taking. Shareholders and investors take risks
when they provide capital, profits act as a
reward for those risks. Dividends act as
incentives to invest more. If bz makes loss,
owners invest elsewhere.
3. Source of finance: Profits after tax and
dividend payments can be used to fund
expansion
4. Indicator of success: Profits enhances bz
image show that investing can be profitable
but losses show that investment must not be
made.
5. Attract finance [k] banks and investors more
likely to invest or lend if bz is profitable
6. Ensures long term survival [k] it will allow
them to continue [an] bz making loss may
eventually close down.
7. Pay employee bonuses [k] to help
attract/retain employees [an] so able to
keep its employees well-motivated
8. A profitable business will have a positive
impact on share price and prices will rise. A
loss-making firm will have a fall in share
price.
K.
C24-25-26
Why Profits Fall ??
1. Failure to plan for change - bz does not adapt
to new technology so will lead to fall in D,
revenue falls, profits fall (an)
2. Over-expansion - bz expand beyond optimal
point so DEOS – AC rise – profits fall
3. Lack of demand for new product - product
fails to make what customers want and needs
4. Substitutes become available – reducing
demand due to high levels of competition
could reduce TR and profits
5. Poor management - owners lack business
experience and did not do MR so may develop
products that do not attract customers
Problems when Profits Fall?
1. Lack of internal finance (k) bz has no RP to
expand so must use bank loans
2. Difficult to obtain loans(k) lenders se bz as
higher risk [an] Banks/Creditors might charge
higher interest rates [k]
3. Workers insecure [k] which results in poor
motivation [an] as they fear job losses as the
bz try to cut costs [app]
4. Damaged reputation [k] customers might
think the business is struggling [an] and look
for alternatives
5. Shareholders may sell shares [k] because the
company can’t pay dividends [an] and owners
cannot make a return on their investment [k]
6. Difficult to attract investment [k] Investors
unwilling to give money (an)
7. Suppliers might not provide inventory [k] so
bz has limited stock app]
4
I/S value to many Stakeholders
1. Shareholders want to know the net profit on
their investments, which will help them
decide whether their share investment
should be continued.
2. Government used thus to assess taxes to
collect; loss making bz is worrying as jobs
could be lost if bz closes down
3. Employees want to know if bz has ability to
pay higher wages in the future.
4. Managers use performance ratios such as
GP, NP and ROCE to improve bz efficiency.
Managers use these info to prepare budgets,
targets, strategy and in decision-making.
C24-25-26
Profit is NOT Same As Cash
Profitable business may run out of cash and have CF
problems. Cash and profit computed differently.
Cash is inflow-outflow; Profit is TR-TC.
Profit is NOT SAME as net cash flow because:
• Credit Sales increases Profit when goods are
sold and is shown in the IS in the month of
sale, but it does not involve cash movements
so will not be shown in the CF till actual receipt
of funds
• Purchase of stock by cash can reduce cash
flow but will not shown in IS until the goods
are actually sold.
• Expansion: Purchase of NCA can cause CF
problems but will show improvements in IS
only in the future
A profitable bz may run out of cash when:
• Business gives credit to customers – no cash
inflows
• Expanding bz has purchased too many NCA –
more cash outflows
• Business repays its long-term loans will result
in a lower cash balance
• overtrading - keeping high inventory levels
leads more cash outflows
5
25.1 SFP
Statement of Financial Position – a document that
shows the value of the business’ assets and liabilities
in a point in time. Shows the net worth of a
business.
1. Assets: Items of value owned by a business
(a) Current Assets –Items owned by business for less
than 1 year and can be quickly converted into cash
(Short-term Assets)
example: Bank, Cash, Trade Receivable, Inventory
Inventory: the amount of raw materials, work in
progress, and finished goods held by a business
intended for sale
Trade Receivables: amount of money owed by
customers for goods bought on credit term
Reasons why business has trade receivables?
(i) Marketing strategy [k] can encourage
customers to buy more goods as they are
able to pay later
(ii) Customers expect credit [k] if they buy
expensive products[app]
(iii) Customers may have cash flow problems [k]
so want credit for goods purchased [app]
(iv) Standard practice in the industry
(b) Non-Current Assets – (Long-term Assets) Items
owned by business for more than 1 year
Example: Buildings, land, company cars
2. Liabilities – Debts owed by business
(a) Long-Current Liabilities – (Long Term Liabilities)
Debts owed by business payable after more than 1
year
example: Long-term bank loans, debentures
C24-25-26
(b) Current Liabilities – (Short Term Liabilities) Debts
owed by business within 1 year
example: Bank overdrafts, trade payables
Bank Overdraft : when the bank gives the business the
right to overdraw its bank account up to an agreed
limit- shown as CL
Trade Payable: amount owed to suppliers for goods
purchased on credit
Reasons why business has trade payables?
(i) Helps with cashflow problems: trade credit us
used by bz as a short-term SOF, buy now but
pay later
(ii) Interest-free source of finance
(iii) Standard way of doing business
Factors suppliers consider before giving credit:
1. Amount of Stock Purchased: if business buys
small quantity-supplier will be on cash terms;
larger purchases more likely to get credit
terms.
2. Credit History: suppliers want to know chances
of being repaid
3. Business Plan: supplier want to know the
viability of the business
3. Equity (Shareholders’ funds) is how much a
business is worth.
(a) Share Capital: value of money invested in the bz
when the shareholders purchased shares
(b) Retained profits: undistributed profits reinvested
in business
SH Funds (equity): value of equity capital plus
reserves. Funds invested into the business by the
owners and all retained profits
SHF= Share Capital + Reserves
SHF = Total Assets - Total Liabilities
6
 25.2 Capital Employed and Working Capital USES of SFP

Capital Employed: Total of long-term and (i) Shareholders can see the value of their stake
permanent capital invested in a business used to pay
for assets. (ii) They can analyze how expansion is paid for:
debts and shareholders investments
CE = LTL+SHF
(iii) Working capital can be calculated

Working Capital: capital needed for running a (iv) Capital employed can be calculated
business on a recurring basis. It is used to pay CL
(v) SFP is used to calculate liquidity, gearing and
ROCE Working Capital = CA – CL efficiency ratio

(vi) SFP useful to shareholders want to know the

FORMAT of SFP return on capital (ROCE) and how the business
uses its capital to earn profits.
Current Assets $1000
Non-Current Assets $4000 (vii) Banks and creditors are able to judge whether
Total Assets $5000 further bank loans should be granted by
looking at the liquidity ratios.
Current Liability $ 800
Non-Current liability $1600 (viii) Managers can know the liquidity and can
Total Liability $2400 measure gearing

Share Capital $2000

Retained Profits 600
Shareholder Funds $2600

Total Liability + SHF $5000

Formula:

Total Assets: CA+NCA $1000+$5000= $6000

Working Capital: CA-CL $1000 - $800= $200

Equity: Share capital + RP $2000 + $600 = $2600

Equity: TA – TL $5000 - $2400 = $2600

Capital Employed: $2600 + $1600 = $4200

SHF + LTL

C24-25-26 7
 Formula:
SHF: Share Capital + Reserves
Capital Employed: LTL + SHF
GP: TR-cost of sales
GPM : GP/Sales x 100%
NP: GP-Operating Expense
NPM : NPAT/Sales x 100%
ROCE: NPAT/Capital Employed
Gearing ratio: LTL/CE x 100%
S= WC: CA-CL
WC: C. Current Ratio: CA/CL
C Acid Ratio: CA-inventory / CL
Ratio Analysis: comparing two figures from the
financial accounts.
There are 2 types of ratios:
• Profitability Ratios – how profitable a
business is- measures performance
3. Return on capital employed measures the amount
of profit made for each dollar invested. Profit of a
business expressed as a percentage of capital invested.
RoCE (%) = Net Profit / Capital Employed x 100%
Capital Employed:- money invested in the business on
a long term basis – total of long-term and permanent
capital invested in a bz used to pay for the bz assets
• High ROCE indicates better ability of
management in using assets/capital employed
to generate profits.
• High ROCE means higher return for every $
invested - more successful
• Low ROCE means profitability fallen OR not
using capital as efficiently as last year
year
One profitability ratio isn’t useful by itself. You need to
use all the profitability ratios and compare it with
previous years of the business.

• Liquidity Ratios – how able a business is to

pay its short-term debts (current liabilities) Why Profit Margin is Important?

26.1 Profitability Ratios
Profitability Ratios: measures bz performance.
Measures profit relative to sales or capital employed
1. Gross Profit Margin (%) – how good a company is
at converting sales into gross profit.
GPM: GP/Sales x 100%
• Rise in GPM is due to higher SP (less rivals)
OR lower costs of production (eos, change
supplier, automation)
• Fall in GPM is due to lower SP (more rivals)
OR rise costs of production (inflation, strong
Trade Union)
1. Measures efficiency [k] This shows how efficient
managers are in converting sales into profits
2. Measures of success/performance/comparison with
other years or with rivals.
Effect of Fall In Profits
1. Fall in dividends to shareholders
2. Fall in share price
3. Fall in Motivation- workers jobs unsecured
4. Need to look for ways to increase added value:
(1) reduce costs or (2) increase prices

2. Net Profit Margin (%) – how good a company is at How to Increase Profitability Margin?
converting sales into net profit. Ability of bz to
control expenses. 1. Increase in Selling Price (improves gpm)
NPM: NP/Sales x 100%
2. Reduced Cost of Sales (improves gpm)
• Rise in NPM means business is better able to
control its operating expenses (lower 3. Good Control Of Operational Expenses
overheads) (improves npm)
• Fall in NPM means business is less able to
control its expenses (higher overheads)

C24-25-26 8
 26.2 Liquidity Ratio
Liquidity Ratios: measures business liquidity
Li. Liquidity: ability of business to pay short-term debts
on time. A measure of how quickly you can turn
(current) assets into cash to pay short term debts
illiquid Illiquid Assets: assets are not easily converted into
cash example: inventory
Liquid Assets: assets are easily converted into cash
example: cash, bank, trade receivables
4. Current Ratio – how a company is to pay off its
current liabilities with its current assets.
it assumes all CA can be turned to cash easily
Above 1.5 – 2.0 is safe
Current Ratio= CA/CL
• fall in ratio means a decline in liquidity and
implies that not all short-term debts can be
met quickly- CF problems. This is probably
due to rapid bz expansion or when a bz pays
off its LT debts.
• rise in ratio means bz is more liquid and can
pay CL on time
5. Acid Test Ratio – measures the ability of a
company to pay off its liabilities without depending
on the sales of inventory .
Should be above 1.0 to be safe
Acid Test Ratio: CA-Inventory/CL
• fall in ratio is when bz has lots of inventory.
This mean that the company might be
illiquid because inventories are hard to
convert to cash easily.
There are many Advantages of Low level of stock:
1. Less capital is tied up in stock or inventory
2. Less space is needed to hold unsold stock –
therefore less rental costs
3. Less overheads if a firm has less stock there
is lower insurance to be paid
4. Less chances of goods becoming obsolete or
outdated
C24-25-26
Reasons for Low Liquidity:
• Expansion: Purchase of too many NCA can
cause liquidity problem
• Purchase of excess inventory in anticipation of
rising demand can lead to a lower Acid
Why Liquidity is very important for a business?
• If they can’t convert their assets into cash,
they won’t be able to pay their suppliers
(current liabilities), workers, overhead
• Not paying suppliers will force them to stop
trading to pay back their debts
• A CR above 1.5 indicates the bz can pay its CL
from its CA.
• An AR above 1.0 indicates the bz can pay its CL
without using inventory
• A business will compare liquidity ratios with
ratios for industry
• Need to know why inventory has rise:
anticipate higher demand or bz is holding
obsolete stock?
Ways to Improve Liquidity
• Delay business expansion
• Delay payment to suppliers, so cash is held in
the business rather than paid out straightaway
• Ask debtors to pay sooner or use debt
factoring
• Use JIT to limit inventory, so less cash is tied up
as inventory
• ask for short term loan or overdraft [k] could
be arranged quickly so able to meet short term
debts
• Take long-term bank loans to inject funds into
the business
• Sell of idle NCA to increase cash/bank balance,
this would release cash held in unused assets
Effect of Low Liquidity/Low AR/QR
1. Make it harder to obtain finance- banks
unwilling to lend
2. Problems paying its short-term liabilities-
forced into liquidation- bz stops trading
3. Suppliers may be less willing to provide goods
on credit
9
6. Gearing: ratio of total capital financed by long-
term debts
High ratio indicated high dependence on loans -
result in higher interest payments
Low ratio indicated lower dependence on loans -
result in lower interest payments
26.3 Users of accounting information
Stakeholder: any person or groups of people who
have an interest in the performance or activities of a
business organization. They can be seen as being
either internal (within the org) or external.
Shareholders (ROCE)
• Shareholders and potential investors use IS
to know business performance, know how
big profit/ loss the company
• Help make investment decisions: SH will
want to check the profitability to decide
whether shareholders have to buy more
shares or not (assess risks)
• Use SFP to know the worth of the business
• Use ROCE to assess profitability of bz and
the efficiency in the use of their funds
• They want to know level of profit (to see
possible dividend) [k]
• To compare with other business.
• To see if increase in share price is po
Workers and trade unions (GPM NPM)
• They will have to want to assess whether the
future of the company is secure or not.
Higher profits indicates job security; loss
making bz are threat to their job security
• Assess the profits to help unions negotiate
better wages and working conditions of
employees
Directors (NPM ROCE CR AR)
• To see how well is the bz doing and see how well
bz objectives are met
• help management in assessing performance –
way to compare with competitors
• help management in assessing performance –
way to compare with previous years
• Identify strength and weakness so can plan what
needs to be done to improve performance
• directors need information to report to
shareholders
Other businesses – competitors (GPM NPM)
• The managers will compare their profitability
and liquidity with other business
C24-25-26
Managers (ROCE NPM, CR, AR)
• Have access to much detailed and frequent
accounting information
• They will be able to identify which business
aspect is doing well and which has a poor
performance
• Help decide how much dividend to pay
• Ratios are a quick way for managers to
compare their ratios with other rivals
• Compare performance with previous years
• Decide which source of finance to use OR
whether to borrow money or able to afford to
borrow
• Help make investment decisions
Trade payable/Creditors/ Suppliers (CR AR Gearing)
• TP: indicates the total value of debts the
business has to pay back to suppliers.
• Suppliers are concerned with cash position of
the business
• Suppliers use Liquidity Ratio to decide the
length of credit time it should give or the
amount of money to lend
Banks (CR AR Gearing)
• To decide whether to give the loan [k]
• Use SFP to identify assets for security [k]to
reduce risk of non-payment
• To calculate liquidity, can it repay short-term
debts and interest
• The SFP shows A, L - so if bz has high debts
(high gearing) - too risky to lend more
• Banks see the accounts of the business would
show the net worth of the company. They
would also show the capital structure. Thus
bank manager would be able to judge whether
a loan was appropriate and what kind of
security could be offered.
Government (GPM NPM)
• To check the tax revenue, whether the firms
are paying the right taxes
• Uses I/S to know how much taxes are to be
collected; if bz making a loss, it wants to know
how many jobs could be lost
Potential Shareholders/Investors (ROCE)
• Fin Info help potential investors make decisions –
might want to know the ROCE/NPM to see if it’s
worth investing in this business
10
 Limitations of accounting records and ratio analysis
• Managers and Existing Shareholders have
access to all accounts data; Potential investors
and external users have access to limited data so
cannot make accurate judgments.
• Ratios are based on past accounting data,
may not indicate future performance
• Accounting data over time will be affected
by inflation so are no longer as useful in the
future
• Different companies may use different ways
of accounting making comparisons difficult
• Accounting data are affected by inflation and
comparison between years could be misleading.
Financial Info Needed before buying/investing in a
Company
(1) Sales forecast – to estimate potential sales revenue.
This will be compared to the predicted costs to see if bz is
capable to generate profits. • net
(2) Cost information – to estimate start-up capital
required so they can plan how it will be sourced
(3) Cash flow forecast – shows estimated cash flows of a
business over a time period - helps in budgeting,
predict any problems with cash flow; needed for loan
application and when asking for bank overdraft. It shows
how bz is managing the cash inflows and outflows of the
business , identify any CF problems and show if bank loans
can be paid back.
to pre
(4) Income Statement – shows whether the business has
covered its costs , if they made a profit or a loss over the
year, owners can see if they will get a return on their
investment, possibility of retained profit; measure of the
success of the business. It can be compared with
competitors and with previous year’s accounts to assess if
the business is improving or getting worse. It shows if
sales are improving or if costs are under control.
(5) Break even analysis – shows the minimum amount of
products sold to just cover costs – target amount to
ensure a loss is not made, can monitor the business and
can show if it needs to do something to stimulate sales.
(6) Current Share Price - SH want to invest in bz whose
shares are most likely to rise in future
(7) Statement of Financial Position - shows value of
Assets, Liability; measure liquidity, gearing levels; shows
net worth of business
CA
C24-25-26
When are shareholders not satisfied with business
performance?
• They are likely to be unhappy if the dividends
are low [k] and the management of the
business is performing poorly compared to
prior years or to rivals.
• GPM, NPM, ROCE are lower
• GPM lower perhaps due to lower price due to
competition OR high costs of sales not passed
to customers
• NPM lower due to poorer control of expenses
• ROCE lower due to lower NP or higher CE. The
management failed to use effectively capital
employed to generate returns for investors.
Evaluation: One cannot make decision based on 1
year data, need information about previous years.
Performance also depends on state of the market
and/or performance of competitors.
Ways to measure Bz Success:
• Increase in sales indicates more customer
satisfaction
• Increase in profits means better ability to
convert sales into profits and good control of
expenses; increase in GPM, NPM, ROCE
• Higher ROCE indicates efficiency of
management in using assets to generate
profits
• Increase Market Share - Market Leader status
- the % of total market sales held by one
brand. A increase in MS from 20% to 25%
means the business is more successful due to a
rise in number of customers
• Higher Share Price
• High Dividends paid out to Shareholders
• Liquidity - reasonable CR and Acid-ratio, good
CF
• Customer Loyalty
• Number of Output/Productivity
• High Quality Products
• Good Reputation
• Worker Satisfaction/ Loyalty
11
1. Current Ratio – how a company is to pay off its current liabilities with its current assets.
Current Ratio= CA/C. Above 1.5 – 2.0 is safe
Co A CA: $500 CL: $300 Co B CA: $500 CL: $800 Co C CA: $500 CL: $100
CR 1.67: 1 CR 0.63: 1 CR 5:1
For every $1 CL, bz has $1.67 CA- For every $1 CL, bz has $0.63 For every $1 CL, bz has $5 CA-
very safe and within ideal range CA- unsafe, bz has CF problems too safe, too much WC is tied
and bz can pay its CL from its CA and could not pay CL from CA up in unprofitable CA.
2. Acid Test Ratio – measures the ability of a company to pay off its liabilities without depending on
the sales of inventory .
Acid Test Ratio: CA-Inventory/CL. Should be above 1.0 to be safe

Co A CA: $500 CL: $300 Co B CA: $500 CL: $800 Co C CA: $500 CL: $100
Invty: $120 Invty: $120 Invty: $120
AR 1.27: 1 AR 0.48:1 AR 3.80:1
For every $1 CL, bz has $1.27 liquid For every $1 CL, bz has $0.63 For every $1 CL, bz has $5
assets - very safe and within ideal liquid assets - unsafe, bz has liquid assets- too safe, too
range and bz can pay its CL from its CF problems and could not pay much WC is tied up in
CA CL from CA unprofitable CA.

3. Profitability Ratio: GPN, NPM, ROCE

Co A Co B Co C
Sales $1000 Sales $1200 Sales $1000
GP $720 GP $670 GP $720
Operating Profit $280 Operating Profit $450 Operating Profit $300
Long-term Loan $1200 Long-term Loan $1200 Long-term Loan $1200
Share Capital $1800 Share Capital $2500 Share Capital $1800

GPM: 72% GPM: 56% GPM: 72%

NPM: 28% NPM: 38% NPM: 30%
ROCE: 9.33% ROCE: 12.16% ROCE: 10%

GPM: This means for every $1 sales, GPM: This means for every $1 GPM: This means for every $1
bz makes GP of $0.72 sales, bz makes GP of $0.56 sales, bz makes GP of $0.72

NPM: This means for every $1 NPM: This means for every $1 NPM: This means for every $1
sales, bz makes NP of $0.28 and sales, bz makes NP of $0.38 sales, bz makes NP of $0.30
have expenses of $0.44 and have expenses of $0.18 and have expenses of $0.42

ROCE: This means for every $1 ROCE: This means for every $1 ROCE: This means for every $1
invested, the bz makes profits of invested, the bz makes profits invested, the bz makes profits
$0.09 of $0.12 of $0.10

Gearing: 40% Gearing: 32% Gearing: 40%

For every $1 invested, $0.40 is For every $1 invested, $0.32 is For every $1 invested, $0.40 is
borrowed capital borrowed capital borrowed capital

C24-25-26 12
Sample 1: Extract of Financial Information of ABC
2020 2021

Sales/Revenue 300 100% 400 100%

Cost of Sales 180 60% 220 55%
Gross Profit 120 40% 180 45%
Expenses 90 30% 144 36%
Profit 30 10% 36 9%
Current Assets 300 320
Current Liability 200 350

Do you think the final performance of ABC has improved?

Yes

• Sales have increased by $100K (app) an improvement of 33%

• Gross Profit increased by $60k an improvement of 50%
• NP increased by $6k or by 20%
• Cost of sales are higher by $40k (22%) due to an increase in sales volume of 33%
• GPM in 2020 is 40%; in 2021 is 45% - improved by 5% so better able to control VC and costs of
productions (cheaper materials, reduced labor costs)
• Overall profits increased by $6k (20%)
No
• Expenses have risen by $54k or nearly 60%; while revenue only rose by 33%
• Expense margin in 2020 is 30%; in 2021 is 36%. There is poor control of expenses.
• NPM in 2020 is 10%; in 2021 is 9% - decreased by 1% despite an increase in GPM of 5%
due to poor control of expenses
• CR in 2020 is 1.5: 1; CR in 2021 is 0.91:2. The bz is less liquid, unable to pay CL on time.
• WC in 2020 is $100; WC in 2021 is $ -30.
Eval: Overall it is a good year, sales and gross profits have risen significantly. However, a 6% increase in
expense margin (36%-30%) reduces the potential gain in GPM which is why NPM is lower by 1%.
Sample 2: Do you financial position of XYZ has improved in 2020

2019 2020
NCA 30 40
CA 16 24
CL 16 20
Net Assets 30 44

Financed by:
LTL 10 20
SHF 20 24
Capital employed 30 44

Yes:
• current ratio improve. 2020 CR 1:1 ; 2021 CR is 1.2:1 so can meet short-term liabilities more easily
• CA rose by $8k , CL rose by $4k; CA increased more than CL so better CR, higher WC

No:

• LTL increased, gearing ratio increased. 2020 gearing is 33%; in 2021 gearing is 45% shows a higher reliance on
LTL
• long-term liabilities increased significantly from $10m to $20m; a 50% rise in NCL
• NCA increased $10m – mostly financed by an increase in long-term debt of $10m

Eval: Overall the financial position is good, liquidity has improved. More data needed to calculate acid-ratio.
Gearing has increased due to business expansion. It is using NCL to pay for rise in NCA. Still below 50% gearing
so its neutral.

C24-25-26 13