2.3 Managing Finance in 20 minutes! (Edexcel A Level Business Recap) #Finance

hi everyone welcome to 2.3 managing Finance there are only three topics in this unit but it is quite a big one it’s a really really important one as well because it includes

quite a few of the the significant calculations in this course A lot of these calculations actually come up again again in theme three in 3.5.2 ratio analysis and in 3.5.2 you kind of and 3.5.1 you recap a lot of the stuff that we do here in 2.3 but we also add to it with a few extra calculations

I’m only going to go through the ones that are covered in theme two so I’m not going to go through Rose or gearing I’m just going to go through the the ones that I mentioned in theme two and then the others will be added as well as a recap to these in the theme three CashNews.co

so we’ve got Profit Liquidity and business failure really the vast majority of this CashNews.co is going to be focused on Profit and Liquidity the business value is just a small part of this unit Profit and

Liquidity are two of the kind of most essential topics when it comes to business Finance so we’re going to start by looking at the first financial

statement which is called the statement of comprehensive Income also known as an Income statement or a Profit loss account one of the fundamental Financial Statements that a business has any of them in the company will publish one

of these it’s part of that kind of Accounting process so it’s really important to understand this statement because this tells us how a business makes Profit and where a business makes Profit so analyzing this can be really really

important so let’s go through the table let’s go through what the table looks like in the different parts of the table and we’ll talk about some numbers as well and do it will not do the calculations but we’ll go through the calculations so this this statement starts with um

our Revenue and then it shows our costs over the course of a period of time so usually this is done over the course of a year and that’s one big distinction between Profit and Liquidity Profit this statement is over a period

of time whereas the statement we’re looking at with Liquidity is going to be on a particular day so we’re going to start with our Revenue that is of course the money that we’ve generated through sales in that period of time we’re going to

then subtract what we call our cost of sales so our cost of sales are the costs involved in making the product are direct costs and by subtracting our cost of sales from our Revenue we get what we call our gross Profit so this is where we take the formula that we

mentioned in 2.2 Revenue minus total costs equals Profit that’s too simplistic really what we need to know is we need to know where we make our Profit do we make our Profit because we’ve got a high amount of

Revenue and a low amount of cost of sales do we make our Profit because we don’t spend much on our fixed costs you know we need to know where we make our Profit so we can analyze where to potentially improve in the future so our gross

Profit is just our Profit after we’ve taken away our cost of sales we then take away our fixed overheads so these will be the non-direct costs but the other things we have to pay for in order to keep the business going taking away these as well will give us

our operating Profit and this is probably the Profit that you most likely see a business publish quite often it’s the net Profit I’m sorry the operating Profit that gets published and it’s also the operating

Profit that we use in some other calculations in theme three finally we take away our Finance and costs and so this would include things like interest this

would include technically tax would go into this sort of category as well but tax has been removed from the statements for the specification and so I’m not going to put them in here because you wouldn’t see them in an exam question but finally by taking away our financing costs we get

our final Profit which is our net Profit so if we look at some figures here we could see our Revenue is two hundred thousand pounds over the course of that year our cost of sales would be 75 000 pounds our fixed overheads would be 50 000 pounds and

our financing cost would be five thousand pounds we can then calculate these three areas gross Profit operating Profit and net Profit so of gross Profit would be Revenue Minus cost of sales so 200 000 minus 75 000

is 125 000. our operating Profit would be our gross Profit minus our fixed overheads so 125 minus 50 equals 75 000 or alternatively it could be our Revenue minus our cost of sales and our fixed overheads you get the same response so in this

situation a business has made a Revenue of 200 000 they’ve got a gross Profit of 125 000 so that is the amount of Profit they’ve got after just paying their cost of sales then you’ve got the operating Profit which

is 75 000 that is the Profit they’ve made after paying off their cost of sales and their fixed overheads and then lastly our net Profit is going to be our operating Profit minus our financing costs or our Revenue minus all

three types of costs and that would give us a net Profit of seventy thousand pounds and that net Profit that is the Profit the business has made at the end of the year they are gonna then you choose what to do with that Profit some

of it might go to shareholders through a dividend some of it might be reinvested into the business as retained Profit which was mentioned in 2.1.1 but there are some calculations we can do to assess these these these figures in a bit more detail and these calculations I mean to be

honest it’s a really easy calculation because it’s the same calculation but for all three different types of Profit so we’re going to do here gross Profit margin which is our gross Profit over our Revenue Times by

100 our operating Profit margin which is our operating Profit over Revenue times 100 and our net Profit margin which is our net Profit over Revenue times 100. and the key thing to be aware of here

is what do these figures actually represent well to figure out our gross Profit margin what we’re actually calculating here is we’re calculating what percentage of our Revenue have we retained as gross Profit so for example in this

situation um you know if we’ve got a gross Profit of 60 for example that would mean that 60 of our Revenue has been kept as gross Profit if our gross Profit margin was 90 that means we’ve kept ninety percent of our

Revenue as gross Profit and the higher this is it suggests that the less we are spending on our cost of sales so for some businesses they will have an incredibly high gross Profit margin if they don’t have very many cost of sales so for

example I go to the gym when I go to the gym there are no cost of sales really for the gym when I go in all of their costs are going to be kind of fixed overheads there’s nothing really that they pay when I go to the gym on one particular day so for a gym you would expect a gross

Profit margin to be in the high 90 percent because their cost of sales are really really low if you were going to compare that data you would compare it to other similar businesses you wouldn’t compare that to for example Sony’s PlayStations where they actually spend a

huge amount of money on manufacturing the products they’re obviously quite expensive so their gross Profit margin might might be much lower but they still might make quite a lot of Profit because of scale or because of potentially low fixed overheads so

it’s what percentage of our Revenue is that type of Profit so operating Profit would be what percentage of our Revenue is operating Profit and then what percentage of our Revenue is net

Profit so you would use this to compare and when we’re comparing data there’s a few things we might potentially look at we would certainly want to compare to our previous data for example have we increased our Profit margins that’s just

we’re being more Profitable so yes we’re being more efficient with our costs we could also compare to competitors potentially although of course it’s worth bearing in mind that competitors all have different levels of differentiation and different objectives and

in terms of that and so there might be some limitations with some of those comparisons but we might look to compare to our competitors and we definitely would like to compare to our objectives if we set a target for gross Profit margin or net Profit margin or

operating Profit margin we would want to set we would want to assess how close we’ve been to that Target or whether we’ve achieved that Target or not so it’s really important to make sure you understand what those three different Profit margins

mean now there’s the last kind of topic here links a little bit to the Liquidity side of things where we’re starting to look at the distinction between cash and Profit so I want to make this really really clear because this is an area that students

quite often get confused with cash is immediate whereas Profit is overtime so for example we’ve talked about our Revenue there not all of that Revenue will have been cashed straight away some of that Revenue may have come

from Credit we’ve given to customers and so the key thing with this is this is looking at it over a period of Time how much Revenue did we generate we might have generated Revenue well I mean in this situation we’ve made quite a bit of

Profit we might not have necessarily had a positive Cash Flow because it depends on when we received the cash from that Revenue Profit is just about Revenue and costs but there are other ways of gaining cash and

there are other ways of spending cash for example a bank Loan does not count as a Revenue so a bank Loan wouldn’t show up on this statement however it would show up when we’re thinking about our Cash Flow so it’s

just a really important distinction to understand the difference between cash and Profit in terms of Liquidity we have another financial statement here we’re going to look at the statement of financial position this statement shows the value of a

business’s Assets and Liabilities on a specified date as we go through this table we’re going to have to understand a couple of key terms here we’re going to have to understand the difference between an asset and a liability we’re going to

have to understand the difference between current and non-current so at the top of this table we would see non-current Assets and a non-current asset first of all an asset is something that a business owns So a non-current asset is something that the business owns that has a cash

value like these I think these things are worth money but we’re unlikely to turn these we’re likely to have these for the long term we’re unlikely to turn these Assets into cash within the next 12 months so things like buildings Machinery vehicles and equipment in

this situation we’re saying that they’re worth 800 000 pounds so these are usually worth quite a lot of money but they’re key to our production so the idea is we we are probably not going to want to sell these and generate cash from these because we need them for our production

however if we were in a bit of financial trouble or we were under utilizing some of these Assets we might then sell them to raise some cash but generally speaking our long-term Assets long-term meaning more than a year we’re going to keep these things for

more than a year so if we’ve got non-current Assets that are worth 800 000 we also surely have some short-term Assets as well and they are what we call our current Assets so this is this this is any any asset anything we own or are owed by

other people within the next 12 months these are going to become cash within the next 12 months if they’re not already cash and so we have here cash in the bank of course cash in the bank is already cashed so that’s the most reliable short-term asset current asset we have stock which

has a value but the intention is that we will turn that stock into cash into you know Revenue within the next 12 months we hope we’ll talk more about that a little bit and then we’ve got receivables which is money that we are owed by our customers and the idea is

because that’s a committed spend we should be very likely to receive that within the next 12 months so this business has non-current Assets of 800 000 we have current Assets worth 160 000. some of that will be cash some of that’ll be stock some of

that’ll be receivables this is about so our Assets are about what we own or what we are owed and we will own soon our Liabilities are about what we owe to other people so we’re going to next start with our current Liabilities it goes

non-current Assets current Assets current Liabilities then obviously we’re going to look at non-current Liabilities in a second our current Liabilities are our Debts that we owe in the next

12 months so this is going to be our payables which is the money we owe to our suppliers much in the same way we’ll have receivables for people who are us wheel or others it’ll also include short-term Loans it will also include tax so in this situation we have current

Liabilities of 110 000 obviously because that’s a liability that’s that’s obviously a negative figure for us that’s going to be shown in Brackets and then we have our long-term Liabilities on non-current Liabilities our

long-term Debts these are going to be our long-term Loans and our mortgages typically these long-term Debts are going to have been taken out to pay for the long-term Assets so mortgages for example will be there to pay for

buildings we might have Loans to pay for machinery and vehicles the idea being that we should have something to show for the Loans we’ve taken out and so you would hope that your Assets are worth more than your Liabilities

that suggest your business owns more than it is than it is than it owes to other people and what this gives us is this gives us our net Assets or Liabilities in this situation if we add up all of our Assets and take away all of our

Liabilities we have a value of 350 000 pounds that means that we have net Assets if we had more Liabilities then we have Assets that would be net Liabilities so in this situation net Assets of 350

000 means we have more Assets 350 000 pounds worth more Assets than we do Liabilities then that’s really important because that effectively shows the value of our business now the next stage in this is our total Equity and

that total Equity shows the total investment in the business and that comes from two factors that comes from our share Capital which is the money that’s been invested by shareholders and then the retained Profit which is technically also been

invested by shareholders but in a different way because it’s money that they’ve chosen not to take out of the business they’ve chosen to put it back into the business which is technically investment from the shareholders because it’s the shareholders money they can choose

what they do with that so our total Equity would be 350 000 pounds as well there’s a suggestion there that what we’ve invested is similar to what we’ve got out of it in terms of value this is obviously if you go to study accountancy at a later level that becomes

much more complicated but I think that’s enough depth for this recap CashNews.co obviously there’s far more you can look at in terms of the depreciation of Assets and what have you and um non-physical Assets in tangible Assets I will

leave you to kind of look at that in you in your own time but this is kind of their summary there are some calculations we can do based around this this table of data so we’re going to look at two calculations here we’re going to look at the current ratio so the current ratio is our

current Assets divided by our current Liabilities and we demonstrate that we show that answer as a number X to one and so whatever that number is so for example if that number is two that means for every one pound of current Liabilities we’ve

got two pounds of current Assets ideally what we want is we want a figure between 1.5 and 2 we want more Assets than we’ve got Liabilities because that suggests that we have more money coming we’re turning into cash within the next 12

months then we have Debt in the next 12 months which suggests we should have no problem paying off those Debts the term Liquidity Liquidity refers to the ability for a business to pay its bills and to keep it you know keep itself

running the ability of a business to generate cash and so this is really really important because if our current Assets are lower than our current Liabilities that suggests we may struggle in the next 12 months to generate enough cash to pay off our bills as they

become due so it’s really important I again the ideal figure is that it’s between 1.5 and 2 to 1 so we have two pounds or one point one pound fifty worth of Assets for every one pound of Liabilities we don’t want that to be too high of of course

it’s better to be too high than too low but if we have it too high that suggests we’ve got a lot of say for example if a business has got a huge amount of cash sitting in the bank there’s a suggestion there that you’re being quite inefficient with that cash if your current

ratio is too high so if your current ratio was like four for example you’ve got four pounds worth of Assets for every current liability could you be potentially investing some of those current Assets into potential growth for the business to make it more

Profitable in the future one downside to that calculation is when we think about our current Assets there is no guarantee that we’re going to receive cash for all those current Assets so the second calculation takes that into consideration

the second calculation is the acid test ratio and that is the same calculation with one difference we’re going to take away our inventories so our inventories are our stock but the reason we’re taking away our stock is there’s plenty of reasons why we may not sell our stock for

example if our stock is a food good then it’s perishable you know we might not sell it before it goes out of date or goes moly or what have you so we have to discard it and so that might be something that we consider an asset a current asset in terms of value but we don’t receive any

Revenue from it it just gets wasted if it’s fashion for example it could go out of trend we might lose out on we might have a huge range of fashion Goods that are no longer in Trend and therefore don’t get sold and therefore don’t turn into Cash which means we

can’t use that cash to pay for our bills and then finally technology can become obsolete so there’s a variety of different ways that stock cannot be sold and so therefore the asset test ratio gives us a more kind of reliable measure of How likely it is that we’re going to be able

to pay our bills what this really generates is when we think about our current Assets but not our inventories we’re really thinking about our liquid Assets or highly liquid Assets meaning the ones that are more likely and more guaranteed to

turn into Cash so those two calculations are showed to X to one we mentioned with the current ratio that the ideal figure was between 1.5 and 2. for the acid test you’re looking at anything above one really so one the 1.5 would be a pretty good asset test ratio and then finally we’ve

got this concept of working Capital working Capital is really important working Capital is one of those topics that they’re going to keep examining because to be completely Frank it’s not answered very well people don’t really

have a very good understanding of what working Capital is working Capital is the cash that we spend and receive on the day-to-day basis so really it’s looking at our current Assets and our current Liabilities it’s

effectively the money that our business has to keep themselves going on a day-to-day and so understanding working Capital is really really important in terms of a key term the last Topic in this 2.3 unit is business failure and effectively what this is talking about is what happens

when businesses manage the Finances we’ve just talked about poorly well we’ve got a variety of different causes we’ve got internal causes of failure

we’ve got external causes of failure so internal causes offer mistakes that businesses have made themselves whereas external causes are from factors that are external to their own actions but will potentially cause a business to fail so we’ve got a few examples of these we’ve got

a lack of Cash Flow if you’ve managed your Cash Flow clearly and you can’t pay a bill and therefore your business has to close because you can’t pay your rent or your or you know what have you or you can’t buy supplies that’s internal

because that’s due to mismanagement if you have poor planning and you haven’t planned ahead and so you haven’t foreseen a potential issue for example with our Cash Flow forecasts that is an internal cause if we haven’t used effective marketing that is

obviously something we’ve messed up with and then potentially if we’ve not led the company very well if we’ve got poor leadership then that might cause business failure as well on the external side we’ve got economic changes so things external in the economy that have caused

maybe potentially a lack of economic activity overall which has affected Us in potentially other businesses as well we’ve got changes in taste and friends of course as well just to give an idea of how Trends change within uh within a within a culture and it could be just that we have a

product that is no longer in in taste and Trend and if we can’t adapt that potentially could cause us to fail and finally we’ve got legislation as well so changes to legislation could potentially Outlaw certain products so for example we’re seeing quite a big Crackdown on certain

products over time um for example tobacco gambling alcohol there’s restrictions coming in and so we could see a plenty of plenty of other examples of legislation that has certainly affected some businesses and made it impossible for them to operate so that covers 2.3 hopefully that’s

been quite useful there’s quite a lot of calculations in there again obviously it goes without saying I’ve focused very heavily on the words and the understanding behind the I mentioned this all the time when I do #1a73e8; text-decoration: none;">Finance behind the numbers it is of course though well worth looking at practice exam questions and looking at practice calculation questions because the best way to get good at these is to do the practice as many times as possible repetition until it becomes

part of your kind of long-term memory there is a exam question finder in the link in our description so you can have a look at that and potentially find some questions on 2.3.1 2.3.2 and of course 3.5.2 which will cover some of the same calculations as well thank you very much