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Unit 5
Finance and Accounting
Key Terms:
1. Types of Expenditure
• Revenue Expenditure: Money spent on daily operating costs, such as raw materials and
wages; short-term in nature.
• Capital Expenditure: Money spent to acquire non-current assets like machinery or premises;
long-term use in the business.
2. Time Frame of Finance
• Short-term Finance: Money borrowed and repaid within one year.
• Long-term Finance: Money borrowed to be repaid over several years.
3. Internal Sources of Finance
• Retained Earnings: Profits kept in the business from previous years.
• Sale of Assets: Selling unused or surplus assets to raise finance.
• Sale and Leaseback: Selling a non-current asset and leasing it back for use, allowing cash
inflow without losing use of the asset.
• Working Capital: Finance from managing current assets like speeding up customer payments
or selling off inventory.
4. External Sources of Finance
• Bank Overdraft: A facility allowing the business to withdraw more money than is in its
account (up to a limit).
• Short-term Bank Loan: A loan to be repaid usually within 12 months.
• Introduce New Partners: Bringing in a new partner to raise long-term finance by sharing
ownership.
• Share Capital: Finance raised through selling shares; gives part-ownership to shareholders.
• Leasing: Renting an asset without buying it outright.
• Hire Purchase: Buying an asset by paying in installments; ownership passes after final
payment.
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• Long-term Loans: Borrowing money for long-term projects, repaid over several years with
interest.
• Mortgages: Long-term loans used to purchase property; repaid over 20–30 years or more.
• Debentures: Long-term loans issued to investors with fixed interest and maturity date; no
ownership given.
• Venture Capital: Finance provided by investors willing to take higher risks; may demand
part-ownership.
• Government Grants and Loans: Grants don’t need repayment; loans do. Used to support
specific economic activities.
• Micro-finance: Small loans given to individuals or small businesses not served by traditional
banks.
• Crowdfunding: Raising small amounts of money from many people, usually online.
5. Types of Costs
• Fixed Costs: Do not change with output (e.g., rent, salaries).
• Variable Costs: Change directly with output (e.g., raw materials).
• Marginal Cost: The cost of producing one extra unit.
• Direct Costs: Can be directly linked to a specific product (e.g., raw materials).
• Indirect Costs (Overheads): Cannot be traced to one product (e.g., administrative salaries).
• Total Cost: Sum of fixed and variable costs.
• Average Cost: Total cost divided by number of units produced.
6. Cost & Profit Centres
• Cost Centre: Part of a business where costs are measured (e.g., department).
• Profit Centre: Part of a business where profit is measured (e.g., a product line or store).
7. Contribution & Break-even
• Contribution: Sales revenue minus variable costs; used to cover fixed costs.
• Margin of Safety: Output produced above the break-even point.
8. Financial Documents
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• Income Statement: Shows revenue, costs, and profit or loss over a time period.
• Trading Section: Part of the income statement showing sales revenue and cost of goods sold
to calculate gross profit.
9. Assets and Liabilities
• Asset: Something the business owns or is owed (e.g., equipment, receivables).
• Liability: Something the business owes (e.g., loans, trade payables).
10. Liquidity Ratios
• Current Ratio: Current assets ÷ current liabilities; measures ability to meet short-term debts.
• Acid Test Ratio: (Current assets – inventory) ÷ current liabilities; stricter measure of liquidity.
11. Profitability Ratios
• Gross Profit Margin: Gross profit ÷ sales revenue × 100.
• Profit Margin (Net Profit Margin): Net profit ÷ sales revenue × 100.
12. Cash Flow Terms
• Cash-flow Forecast: Estimate of future cash inflows and outflows over a time period.
• Net Cash Flow: Total inflows – total outflows.
13. Trade Credit Terms
• Debt Factor: A business that buys a firm’s unpaid customer invoices at a discount and
collects the debts.
• Trade Receivable (Debtor): A customer who owes money for goods bought on credit.
• Trade Payable (Creditor): A supplier to whom the business owes money for goods bought
on credit.
Question and answers:
1. A business sells its goods on credit and is awaiting payment from a number of customers. It is
short of funds to pay the wages of its employees. Explain which source of finance you would
recommend that the business uses to pay the wages. (8)
The best source of finance for the business to pay employee wages in this situation is a bank
overdraft. This is because the business is experiencing a short-term cash flow problem — it has
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already sold goods on credit and is simply waiting for payment from customers. A bank
overdraft allows the business to withdraw more money than it has in its account, up to an
agreed limit. This extra money can be used to cover urgent expenses such as employee wages.
Since the business expects to receive payments soon, an overdraft is ideal as it provides quick
and flexible access to funds without the need for long-term borrowing. It is also faster to
arrange compared to applying for a loan or introducing new partners. While other sources like
debt factoring or selling assets may provide cash, they are more complex or result in long-term
implications. Therefore, a bank overdraft is the most suitable and efficient source of finance to
solve the immediate need for paying wages.
2. Advantages and disadvantages of sources of finance:
Source of
Advantage Disadvantage
Finance
- No interest payments required- No - Depends on previous profits-
Retained
repayment needed- Instantly available- Shareholders may prefer dividends
Earnings
No external debt created instead
- Permanent source of finance- Quick - May reduce assets too much-
Working
access via sales or faster payments- Customers may dislike early
Capital
Refreshes old inventory payments- May not raise enough
- Interest payments required-
- Fixed amount and time- Possible fixed
Long-term Repayments start immediately-
interest- Ownership/control remains-
Loans Requires collateral- Risk of asset
Helps with budgeting
loss
- Permanent finance- Can raise large - Ownership dilution- Limited by
Share Capital
amounts authorised share capital
Introduce New - Quick access to funds- Permanent - Loss of ownership/control- Sole
Partners source of finance traders lose independence
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Activities on Finance:
1. Identify Costs in a Café
Scenario: A small café has the following monthly expenses:
• Coffee machine lease: $600
• Wait staff wages: $800 per staff member
• Coffee beans and milk: $0.70 per cup
• Utility bills: $200 fixed, plus $0.05 per cup sold
• Social media advertising: $250
• Napkins and takeaway cups: $0.20 per customer
Task:
Students must classify each cost as fixed or variable.
2. T-Shirt Printing Business Analysis
You run a T-shirt printing business. The costs and price structure are as follows:
• Fixed costs: $800 per month
• Variable cost per T-shirt: $6
• Selling price per T-shirt: $15
Task:
Complete the table below on your own.
Output (T- Total Variable
Total Cost Revenue Profit Average Cost
shirts) Cost
100
200
300
400
500
Instructions for Students:
i. Use the given data to fill in each column of the table.
ii. Calculate:
o Total Variable Cost = Output × Variable cost per unit
o Total Cost = Fixed Cost + Total Variable Cost
o Revenue = Output × Selling Price
o Profit = Revenue − Total Cost
o Average Cost = Total Cost ÷ Output
Once completed, answer the following questions on your sheet:
(a) At which output level is profit the highest?
(b) At which output level is the average cost the lowest?
(c) What can you conclude about how output affects profitability?
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4. Break-even Calculation Using Formula and Diagram
Exercise:
Selling price: $25 per soap bar
Variable cost: $10 per soap bar
Fixed costs: $2,250
Task:
Calculate the break-even point in units using the formula:
Break-even point= Fixed Costs / (Contribution) Selling Price−Variable Cost
Draw a break-even chart showing:
• Total Revenue Line
• Total Cost Line
• Break-even Point
• Area of Profit and Loss
Instructions for Students:
(a) Complete the calculation on your worksheet or notebook.
(b) Use graph paper to accurately draw the break-even chart. Label all parts clearly.
5. Individual Activity: Ratio Analysis – Mobile Accessories Business
Scenario:
You are analyzing the financial health of a small business that sells mobile accessories. The following
data is provided:
Data:
• Current Assets: $20,000
• Inventory: $5,000
• Current Liabilities: $8,000
• Sales Revenue: $60,000
• Cost of Sales: $42,000
• Other expenses: $9,000
Task:
(a) Calculate the following ratios:
• Current Ratio = Current Assets ÷ Current Liabilities
• Acid Test Ratio = (Current Assets − Inventory) ÷ Current Liabilities
• Gross Profit Margin = (Gross Profit ÷ Sales) × 100
• Net Profit Margin = (Net Profit ÷ Sales) × 100
(Note: Gross Profit = Sales − Cost of Sales)
(b) Briefly answer:
Discuss why high current ratio doesn’t always mean a business is in a good financial position.
6. Individual Activity: Cash Flow Statement – Coffee Shop Business for Three Months
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Scenario:
You are tasked with preparing a cash flow statement for a small coffee shop for the months of April,
May, and June. The following data is provided:
Data for April:
• Cash in hand at the start: $3,500
• Cash sales: $8,000
• Receipts from debtors: $2,000
• Wages paid: $2,200
• Rent paid: $1,800
• Purchase of new equipment: $3,000
• Payment to creditors: $1,500
Data for May:
• Cash in hand at the start: $4,000
• Cash sales: $8,500
• Receipts from debtors: $2,500
• Wages paid: $2,400
• Rent paid: $1,800
• Purchase of new furniture: $2,500
• Payment to creditors: $1,700
Data for June:
• Cash in hand at the start: $4,600
• Cash sales: $9,000
• Receipts from debtors: $2,800
• Wages paid: $2,500
• Rent paid: $1,800
• Purchase of coffee machines: $3,500
• Payment to creditors: $1,600
Task:
Prepare a cash flow statement for the coffee shop for each month, showing:
• Total Inflows
• Total Outflows
• Net Cash Flow
• Closing Balance (for each month)
Extension Activity:
After completing the cash flow statement, analyze which month the business had the highest cash
flow surplus or deficit and provide recommendations on improving cash flow management for the
next quarter.
