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).

This quiz covers key finance concepts such as Net Present Value (NPV), Internal Rate of Return (IRR), and the Payback Method. You'll explore the pros and cons of each method and understand their implications in financial decision-making. A great resource for students in finance.