2.3

• Profit is long term and cash is physical. Cash inflows and outflows are not recorded until it has been received/processed
• Profit

  When a business takes their costs away from their revenue

  3 ways to calculate profit

  Gross profit

  Operating Profit

  Net Profit
• Gross profit is revenue(sales turnover) takeaway variable costs(cost of sales)

  Gross profit refers to the profit made after direct costs have been met
• Operating Profit is Gross profit minus operating expenses (overheads)
• Net Profit

  Profit for the year

  It is operating profit minus interest and exceptional costs(tax,interest etc)

  Net profit may be calculated before or after the subtraction of tax.
• Statement of comprehensive income

  Another name for a Profit and Loss account
• Profit and Loss account
(also known as statement of comprehensive income)

  A statement that shows the financial performance of a business during a 12 month period

  Shows current and previous years financial figures this allows a comparison to be made

  Details in the document:tax is considered in this account and profits are calculated
• Why is it a good idea for businesses to calculate profit/loss?

  Shows financial health of a business and can be compared with other years and highlight progress.

  Studied by managers shareholders,bank financers etc

  Shareholders in particular are interested in trends in profit

  To avoid failure

  Limited companies pay corporation tax

  Sole traders and partnerships pay income tax

  PLCs are required to publish their profit and loss accounts
• Businesses work out percentage increase or decrease on the profits to measure against previous years.

  Percentage change in profit=current year profit-previous year/previous year profit x100
• A statement of financial position

  A snapshot of the financial position of the business at that moment in time. It provides a summary of a firm's assets,liabilities and capital.

  Equity is the total of what is owed to shareholders.
• Assets - something that is owned by the business like vehicles,stock,cash buildings etc
• Liabilities - these are what the business owes to others,a source of debt
• Capital - used to buy assets,money put into the business e.g owners capital,share capital
• Shareholders equity - what is owed to the shareholders,retained profit and share capital
• Balance sheet

  The same as a statement of financial position

  A balance sheet should always balance out figures

  The value of assets will equal the value of liabilities
• Working capital is the term used to describe the money used for day-to-day activities within a business. Used to pay expenses,electricity and raw materials. It is all money left over after current debts have been paid.

  Working capital=current assets - current liabilities

  It is very important as it can reflect how well a firm is performing.
• Balance sheets work with the statement of comprehensive income(a profit and loss account)

  Both balance sheets and profit and loss accounts show the 'health' of the business.
• Current assets are items owned by the firm that can be turned into cash within 12 months.

  If it was a concert ticket for a concert in 8 weeks it would be a current asset as it can only be sold with in the next 8 weeks.

  If the case study doesn't specify that the asset will be sold it does NOT class as a current asset even if it could be turned to cash in 12 months
• Non-current assets are long term resources used repeatedly by the firm

  e.g land property etc

  Not expected to be sold within 12 months
• Current liabilities is money owed by the firm that must be repaid within 12 months
• Non-current liabilities relate to long term loans and other money owed by the firm e,g mortgages that have to be paid for at least 1 year.
• Net assets are calculated by subtracting the value of total liabilities from total assets.
• Liquidity - the ease at which assets can be converted into cash.

  It is important the firm is able to meet its short term debts as failure to do so may result in closure of the business.
• Liquidity ratios assess the firm's ability to pay their day-to-day running costs. If the firm has too little money available the business is illiquid. The value of this is to give a warning about when the current liabilities are getting too high in relation to current assets.
• Current ratio

  This ratio shows how many £ of current assets a firm has to every £1 of current liabilities.

  It shows whether a firm will be able to pay its bills.

  Current ratio= current assets/current liabilities

  Current ration:1 (must be displayed in this form)
• Ideal ratio

  Between 1.5 and 2:1 (between 1 and 3:1 = healthy business)

  A ratio of 3:1 would imply the firm has £3 assets to cover every £1 in liabilities.

  A ratio of 0.75:1 would suggest the firm only has 75p in assets to cover every £1 in liabilities.

  If it is any higher than 3 the firm is unproductive and their is too much cash tied up in stock

  If it is lower than 1 the firm can't pay off its debts
• Acid test ratio

  If assets are given as a whole then you need to subtract the stock but if the assets are in a list you just exclude stock.

  e.g total assets= 1000 and stock=250 you do 1000-250

  but if it is listed as separate assets like 300,200,250 and then stock 250 you just don't include stock

  Current assets - stock/current liabilities :1

  Ideal figure is above 1

  Harsher method.
• Managing working capital

  Size of business,the larger the business the larger amount of WC

  Stock levels,firms that adopt JIT will have lower WC figures

  more stock=higher WC

  Debtors and creditors

  time between buying stock on trade credit and selling finished product can influence WC levels
• Ways to improve liquidity

  Use overdraft facilities

  Negotiate additional short term and long term loans

  Encourage cash sales

  Sell assets and lease back

  Make only essential purchases.
• Internal causes of business failure

  Lack of planning

  Cash flow issues

  Lack of funds

  Relying on a narrow customer base

  Marketing problems

  Failure to innovate

  Lack of business skills

  Poor leadership
• External causes of business failure

  Changes in legislation

  Changes in consumer tastes

  Change in market price/growth

  Economic conditions

  Competition
• Financial reasons for business failure

  Shortage of cash resulting in closure or bankruptcy. The importance of cash flow management can't be overemphasised
• Non-financial reasons for business failure

  All issues must be addressed. Failure to meet customer needs,compete effectively or adapt to economic demands may result in cash flow issues and thus closure.