Finance Concepts Overview

Limiting Factors

• A factor of production that restricts the level of activity or output.

Provision

• A liability with uncertain timing or amount.

Net Present Value (NPV)

• Pros: Considers the time value of money (inflation), reflecting higher value of money today.
• Cons: Cost of capital estimation can be subjective, potentially leading to inaccurate NPVs.

Payback Method

• Pros: Simple calculation, easily understood by managers and non-accountants.
• Cons: Ignores profits after the payback period.

Average Rate of Return

• Pros: Focuses on profitability, a key objective for many firms.
• Cons: Doesn't account for the time value of money (inflation).

Internal Rate of Return (IRR)

• Definition: The percentage return an investment is expected to generate over its lifespan.
• Must exceed the weighted average cost of capital (WACC) for profitability.
• Pros: Facilitates comparison of projects with varying lifespans by identifying the discount rate making NPV zero.
• Cons: Computationally complex, possibly challenging for non-accountants.

Profitability Index

• Pros: Enables comparison of returns for different projects, even with dissimilar sizes.

Decrease in Inventories

• Pros: Reduces storage costs (warehousing, security).
• Cons: Limits inventory options, potentially hindering large orders.

Decrease in Trade Payables

• Pros: May enhance creditworthiness, improving future credit access.
• Cons: Decreases short-term liquidity available for other business purposes.

Share Purchase

• Reasons: Future share price appreciation and/or increased control of other companies, such as suppliers.

Share Issue

• Reason: Raising capital and potentially reducing the gearing ratio.

Budget Preparation Process

• Step 1: Identifying limiting factors influencing budgets (e.g., production).
• Step 2: Consulting with departments for feedback and realistic estimations.
• Step 3: Creating a master budget (a comprehensive budgeted statement).

Goodwill Calculation

• Factors: Calculated from annual profits (higher profit = higher goodwill) and firm reputation/brand awareness. Goodwill is often a multiple of annual profits.

Marginal vs. Absorption Costing

• Marginal Costing: Allocates costs to periods, potentially providing a more accurate profit picture for a specific period. Often aligns with prudence accounting principles.
• Absorption Costing: Allocates costs to products, aiding managers in assessing product profitability. More directly aligns with the matching concept by matching costs with revenues.

Record Card

• Pros: Clearly shows receipts, issues, and balances. Low inventory levels trigger reorder alerts. Reduces likelihood of theft by providing clear tracking.
• Cons: Doesn't track production-based inventory use. Maintaining accuracy requires constant updates.

Share Premium Account Uses

• Uses: Issuing bonus shares and offsetting expenses incurred during the company’s formation.. Also used to pay premium on shares redeemed.

ICT in Business

• Financial:
  • Pros: Automates transactions, potentially reducing accountant reliance for financials and taxes.
  • Cons: High upfront costs of hardware/software, reliance on technical expertise for maintenance, employee training, and susceptibility to data loss from computer failure, power loss or inadequate backups.
• Technical:
  • Pros: Maintains records orderliness, minimizes errors (e.g., automatic double-entry). Improves speed in producing financial statements and calculations.
  • Cons: Potentially unnecessary for limited bookkeeping. Relying on IT introduces risk of data loss or damage. Bank statements may fulfil simpler bookkeeping.
• Human:
  • Pros: Can reduce workload and improve business efficiency
  • Cons: May present initial learning curve and require adaptation. Higher costs outweigh the benefits in small firms relative to large firms.

Budget Evaluation

• Pros: Forecasting future performance, streamlining planning, enabling control over costs through variance analysis. Coordinated departmental efforts and improved operational efficiency.

• Cons: Forecasting inaccuracy. External factors beyond management control. No benefit from fixed budgets if costs don’t change significantly.

Project Appraisal (General)

• Criteria include project NPV or IRR. Average Rate of Return (ARR) consideration. Payback period evaluation. Analysis of gearing ratio. Profitability index. Estimating inaccuracies.

Project Evaluation (Standard Costing)

• Variance analysis, evaluating labor efficiency, rate, material usage, and price variances (favorable vs adverse).

Auditor Roles

• Areas of Audit Focus: Enquiring and documenting board responsibility divisions and appropriate election intervals; risk management (e.g., M&A); compensation committee roles; shareholder notification for AGMs.

Redemption of Shares

• Pros: Increased Return on Capital Employed (ROCE), potentially reduced future dividend burden.
• Cons: Reduced financial flexibility/liquidity. Potential deterrents to further investment.

Purchases on Credit

• Pros: Potentially increased sales and market share.
• Cons: Risk of bad debts and associated collection costs.

Merger Evaluation

• Pros: Broader market diversification, economies of scale (EOS), expansion.
• Cons: Dilution of ownership (if shares issued), liquidity decline (if cash outlay).

EPS Improvement

• Methods: Increase net profit, lower interest rates, reduce taxes, decrease share count.

Gearing Ratio Evaluation

• Pros: Determining if debt utilization was beneficial.
• Cons: Impact of higher interest costs on profitability. Concerns of debt repayment failure, collateral risks, and impact on dividend payments and share price.

Dividend Evaluation

• Pros: Keeping shareholders satisfied, potentially increasing share price (if dividend yield attractive).
• Cons: Reducing available liquid capital.

Debentures Evaluation

• Pros: Potentially lower interest rates, accessible when bank loans are restricted.
• Cons: Risk of collateral forfeiture. Larger, less frequent interest payments.

Liquidity Evaluation

• Factors: Assessment of cash and cash equivalents. Analysis of current ratio and acid-test ratio improvement or decline over time (compared to previous years). Liquidity related to external factors such as obtaining new loans or issuing shares.

Disclosure of Discontinued Operations

• Pros: Providing a more accurate view of future performance to stakeholders. Ensures fair representation in accounts.
• Cons: Adds complexity to the financial statements. Adds costs to providing such information.

Flexible Budget Evaluation

• Pros: Enabling comparing different output levels, facilitating efficient decision-making based on variance analysis, proactive planning, and cost/revenue forecasting. Detailed variance analysis.
• Cons: Time commitment in creating and maintaining. Potential uncertainties in estimations.

Bonus Share vs. Dividend Issue

• Bonus Shares: No cash outflow for the company.
• Final Dividends: Retaining control of existing shares. Attractive dividend yields attracting investment. Potential risk associated with issuing more shares (lower share price).