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5.1. Business finance

Finance need	Typical time horizon	Why cash is needed
start-up	long-term plus initial working capital	premises, equipment, launch costs and early bills
expansion or growth	mainly long-term	extra capacity, locations or non-current assets
replacement or new technology	medium- or long-term	restore capacity or improve productivity
working capital	short-term	inventory, wages, suppliers and other day-to-day payments

$working\ capital=current\ assets-current\ liabilities$

Working capital keeps the operating cycle moving while cash is tied up in inventory and trade receivables. Too little can cause late payments, interrupted production or insolvency; too much may mean cash is being used inefficiently.

Positive working capital is not the same as cash or profit. Match the length of finance to the need: a long-lived asset should not normally depend on finance that can be withdrawn at short notice.

Source	Internal or external	Main trade-off
owners’ investment	internal	no interest, but owners risk more capital
retained profit	internal	no repayment, but unavailable to a new or unprofitable business
sale of unwanted assets / release of working capital	internal	raises cash, but may reduce capacity or liquidity
shares	external equity	permanent capital, but ownership and control are diluted
venture capital	external equity	specialist investors fund high-growth, high-risk firms, but expect ownership, influence and a return
overdraft / trade credit	external short-term	flexible for cash-cycle gaps, but can be costly or withdrawn
leasing / hire purchase	external asset finance	spreads payment; leasing gives no ownership, while hire purchase usually ends in ownership
bank loan	external debt	suitable for a defined period, but interest and repayments strain cash flow
grant / crowdfunding	external	may avoid repayment, but eligibility or campaign success is uncertain

Judge legal form and size, amount required, duration, purpose, existing debt and security, total cost, repayment cash flow and the owners’ willingness to share control. Then link the chosen source directly to the case and compare it with a realistic alternative.

For example, an established company buying machinery for several years might prefer a term loan or hire purchase: both match the asset life. An overdraft may be better for a temporary working-capital gap, but is risky for the machinery because it is short-term and may be recalled.

There is no universally best source. ‘Cheapest’ is incomplete unless cost, risk, control, availability, timing and repayment capacity are all considered.

5.2. Cash flow forecast

Cash lets a business pay wages, suppliers and other bills when they fall due. A cash flow forecast is an estimate of future cash entering and leaving the business over time. It helps managers anticipate a shortage, plan payments and finance, test a decision and set targets before the cash movement happens.

Forecast feature	Meaning
cash inflow	cash received, such as cash sales or customer payments
cash outflow	cash paid, such as wages, suppliers, rent or equipment
net cash flow	inflow minus outflow for that period; it is negative when outflow is greater
opening balance	cash available at the start of the period; normally the previous period's closing balance
closing balance	opening balance plus net cash flow; it becomes the next period's opening balance

\text{net cash flow}=\text{cash inflow}-\text{cash outflow}\text{closing balance}=\text{opening balance}+\text{net cash flow}

Worked amendment: if month 3 inflow is revised to $1,500 and outflow is$ 1,200, net cash flow becomes $300. With an opening balance of −$ 1,200, the revised closing balance is −$900. Carry the sign carefully: a negative closing balance signals a forecast cash shortage, even if the business may be profitable over a different period.

Short-term response	Immediate cash-flow effect	Important cost or risk
use an overdraft	permits a temporary negative bank balance	interest and limits apply
delay supplier payments	keeps cash in the business longer	may lose discounts or damage supplier trust
ask customers to pay sooner	brings inflow forward; a discount may encourage prompt payment	the discount reduces revenue per sale or stricter terms may deter customers
delay buying non-current assets	postpones a large outflow	old equipment or delayed expansion may reduce efficiency or growth

A forecast is an estimate, not a guarantee, so revise it when assumptions change. Completing or amending given rows and interpreting their effect is required; constructing an entire forecast from a blank page is outside this syllabus. Cash is also not the same as profit: a profitable business can still fail if it cannot pay bills on time.

5.3. Profit and loss

Profit is the amount left when a business subtracts all its costs from its revenue for a period. It is not the same as revenue, and it is not the same as cash available on a particular day.

\text{profit}=\text{revenue}-\text{total costs}

Why profit matters	Business mechanism
reward for risk-taking	compensates owners or shareholders for committing money, time and enterprise when success was uncertain
source of finance	retained profit can fund assets, expansion or product development without new borrowing or ownership
measure of success	changes in profit help assess products, managers or the business over time, although context and scale still matter
attract investors	a credible profit record can make future returns appear more likely and help a company raise equity finance

A high profit figure alone does not prove that cash flow is healthy or that every product succeeds. Use profit with the time period, business size and supporting financial information before judging performance.

A statement of profit or loss summarises financial performance over a period. Revenue is reduced first by cost of sales to find gross profit, then by expenses to find profit. Each subtotal answers a different management question.

\text{gross profit}=\text{revenue}-\text{cost of sales}\text{profit}=\text{gross profit}-\text{expenses}

Feature	Meaning and useful rearrangement
revenue	income from sales; $\text{revenue}=\text{gross profit}+\text{cost of sales}$
cost of sales	cost of producing or buying the goods sold; $\text{cost of sales}=\text{revenue}-\text{gross profit}$
gross profit	amount left after cost of sales, before expenses
expenses	other operating costs; $\text{expenses}=\text{gross profit}-\text{profit}$
profit	final amount after cost of sales and expenses

Worked comparison: Company A has revenue $100m and cost of sales$ 40m, so gross profit is $60m. If expenses are$ 40m, profit is $20m. Company B has revenue$ 200m, cost of sales $90m and expenses$ 60m, giving gross profit $110m and profit$ 50m. B earns more profit, while A converts a larger share of revenue into gross profit; the decision depends on the buyer's aim and acquisition cost.

Use the statement to identify whether a change comes from sales, cost of sales or expenses; compare performance with earlier periods or another business; test whether a product or operation should continue; and support investment or finance decisions. State the calculation, explain what it shows, then add the contextual limitation before recommending.

You must calculate and decide from a supplied statement, but you are not assessed on constructing a complete statement from a blank page. A larger business may show more profit simply because it has more revenue, so raw totals are not always enough for comparison.

5.4. Statement of financial position

Element	Meaning	Examples
non-current assets	resources kept for long-term use	property, machinery
current assets	resources expected to become cash within the operating cycle	inventory, trade receivables, cash
non-current liabilities	debts due after more than one year	long-term bank loan
current liabilities	debts due within one year	trade payables, overdraft

$total\ assets=noncurrent\ assets+current\ assets,\quad total\ liabilities=noncurrent\ liabilities+current\ liabilities,\quad working\ capital=current\ assets-current\ liabilities$

Capital employed is the long-term finance invested in the business. It can be viewed as equity plus non-current liabilities, or as total assets minus current liabilities.

Use the figures to judge asset structure, liquidity and borrowing. A rise in non-current assets may show investment; weak or negative working capital may signal difficulty paying short-term debts. Compare with earlier years or similar businesses before deciding.

A statement of financial position is a snapshot at one date, not a record of profit or cash movement. Candidates use and calculate from a simple statement; they do not need to construct one from scratch.

5.5. Analysis of accounts

Profitability measures how effectively a business turns revenue or invested capital into profit. Ratios make comparison across years or businesses more meaningful than profit alone.

$gross\ profit\ margin=\frac{gross\ profit}{revenue}\times100,\quad profit\ margin=\frac{profit}{revenue}\times100,\quad ROCE=\frac{profit}{capital\ employed}\times100$

Ratio change	Possible interpretation
gross profit margin falls	selling prices weakened or cost of sales rose
profit margin falls while gross margin is stable	operating expenses rose
ROCE rises	more profit is generated for each unit of long-term finance

A higher ratio is usually favourable, but not conclusive. Check the cause, time period, accounting policies, business type and any trade-off such as lower prices used to build market share.

Liquidity is the ability to meet short-term debts when they fall due. It depends on the quality and timing of current assets, not simply their total value.

$current\ ratio=\frac{current\ assets}{current\ liabilities},\qquad acid\! -\! test\ ratio=\frac{current\ assets-inventory}{current\ liabilities}$

The acid-test ratio removes inventory because it may be slow to sell or lose value. Ratios that are too low can signal payment difficulty; very high ratios can signal idle cash, excessive receivables or inventory. Compare with prior years and the needs of the industry.

A current ratio above 1 does not guarantee bills can be paid: receivables may arrive late and inventory is not cash. A retailer can also operate safely with a lower acid-test ratio than a business that holds little inventory.

User	Internal or external	Example decision
sole trader, partners or shareholders	internal owners	invest, withdraw profit or change strategy
managers	internal	control costs, pricing and finance
employees	internal	assess job security or support a pay claim
suppliers	external	offer trade credit
lenders or banks	external	approve a loan and set terms
government	external	assess tax or compliance

Identify the user’s decision, select relevant profit, liquidity or position figures, calculate consistently, compare with a useful benchmark, and explain what the result implies for that user.

Accounts are historical and may use different accounting policies. Inflation, seasonality, one-off events and window dressing can distort comparisons. Ratios omit qualitative information such as product quality, employee skills, market change and future cash flows; published accounts may also be too aggregated or out of date.

One ratio cannot prove that a business is safe, profitable or worth financing. Use several linked measures plus context and non-financial evidence.

5. Financial information and decisions

Exam analysis

Most tested topics

5.1. Business finance

Match finance to the business need

Choose and justify a source of finance

5.2. Cash flow forecast

Reading and repairing a cash flow forecast

5.3. Profit and loss

Why profit matters

Using a statement of profit or loss

5.4. Statement of financial position

Read a statement of financial position

5.5. Analysis of accounts

Measure and interpret profitability

Measure and interpret liquidity

Use accounts for decisions—without overclaiming