Unit 3 Key terms - Finance & accounts

Unit 3 Key terms - Finance and Accounts

Finance is vital to a firm's operations

It is through the correct use of subject terminology that students show their knowledge and understanding. This section of the IB Business Management syllabus looks at the finances of business organizations.

The finance and accounts section of the course examines aspects of financial control (such as cash flow and budgeting) and financial management accounts (such as the balance sheet, income statement and ratio analysis).

All business decisions have two impacts:

1. the impact on human resources (see Unit 2 - HRM), and

2. the impact on the organization's finances.

Unit 3.1 Key terms - Source of finance

Business angels	Wealthy and successful private individuals who risk their own money in a business venture that has high growth potential.
Capital expenditure	Refers to business spending on fixed assets or capital equipment of a business, such as spending on buildings, machinery and tools.
Debt factoring	A financial service provided to businesses that are struggling to collect money from their debtors so face liquidity problems.
External sources of finance	Finance that comes from outside the organization, usually with the help of a third party provider, such as a bank, business angel, venture capitalist or government.
Grants	Type of financial aid for businesses, paid as a lump sum from the government, which does not need to be repaid.
Initial public offering (IPO)	Finance raised by a public limited company when it issues (sells) shares for the very first time on a stock exchange.
Internal sources of finance	Finance that come from within the organization, from its own resources and assets without the help of a third party provider.
Leasing	This financial service enables businesses to have access to fixed assets, by hiring these assets, but without the high costs of capital expenditure.
Loan capital	Also known as debt capital, this refers to borrowed funds from financial lenders, such as commercial banks.
Long-term finance	Refers to sources of finance of more than five years, for the purchase of long-term fixed assets or to fund the growth of a business in overseas markets.
Medium-term finance	Refers to all sources of finance of one to five years in duration. The finance is used mainly to pay for fixed assets, i.e. capital expenditure.
Overdraft	A banking service that enables customers (personal and business customers) to withdraw more money from their account than exists in the account.
Personal funds	Internal source of finance, with entrepreneurs using their own savings, usually to finance their start-up business.
Retained profit	Also known as ploughed-back profit, this is the surplus funds that are reinvested back in the business, rather than being distributed to the owners.
Revenue expenditure	Refers to business spending on its everyday and regular operations, such as spending on wages, raw materials and bills.
Share capital	Also known as equity capital, this is finance raised through the issuing of shares via a stock exchange (or stock market).
Share issue	The process involving a public limited company selling additional shares in order to raise finance.
Short-term finance	Refers to sources of finance needed for the day-to-day running of the business, i.e. revenue expenditure.
Stock exchange	A highly regulated marketplace where individuals and businesses can buy and sell shares in public limited companies.
Subsidies	Form of government assistance, provided to encourage firms to increase their output of certain goods or services, which are deemed to be beneficial for society as a whole.
Trade credit	Financial service that enables a business customer to purchase and obtain goods and services but to pay for these at a later date.
Venture capitalists	Financial institutions and investment banks that invest in start-up firms and/or small but expanding businesses with significant growth potential.

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Unit 3.2 Key tems - Costs and Revenues

Average costs	This is the cost per unit of output. It is calculated by the formula: AC = TC ÷ Q where: AC = Average cost TC = Total cost, and Q = Quantity of output.
Average revenue	This is the amount a business receives from its customers per unit of a good or service sold. Mathematically, AR = TR ÷ Q = P where: AR = Average revenue TR = Total revenue Q = Quantity of output, and P = Price.
Costs	The charges that an organization incurs from its operations, such as rent, wages, salaries, and insurance.
Direct costs	Costs that are clearly associated with the output or sale of a certain good, service or business operation, such as raw materials.
Fixed costs	Costs that do not change with the level of output, such as loan repayments and management salaries.
Indirect costs	Also known as overhead costs, these costs are not easily identifiable with the sale or output of a specific good, service or business operation.
Price	Also known as average revenue, this is the amount of money a product is sold for. Hence, mathematically, AR = P.
Revenue	The money (income) received by a business from the sale of goods and/or services.
Revenue stream	The different sources of revenue (or income) for a business, such as revenue from sponsorship deals, merchandise sales, membership fees and royalties.
Semi-variable costs	Costs that have a fixed and variable features, such as power and electricity or salaried staff who also earn commission.
Total costs	This refers to the aggregate amount of money spent on the output of a business. The formula is: TC = TFC + TVC where: TC = Total costs TFC = Total fixed cost, and TVC = Total variable cost.
Total revenue	This is the sum of income received by a business from its trading activities. It is calculated using the formula: TR = P × Q where: TR = Total revenue P = Price, and Q = Quantity of output.
Variable costs	Costs that change with the level of output - they rise when output or sales increase, such as the cost of raw materials or packaging costs.

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Unit 3.3 Key terms - Break-even analysis

Break-even	This condition exists when a firm’s sales revenues cover all of its production costs.
Break-even point (BEP)	This is the point on a break-even chart where the firm’s total costs (TC) equal its total revenue (TR), shown by the intersection of the TR and TC curves.
Break-even quantity (BEQ)	The quantity of sales (sales volume) required for a firm to reach break-even. It is found by using the formula: BEQ = TFC / (P – AVC) where: TFC = Total fixed costs P = Price, and AVC = Average variable cost.
Break-even revenue	This is the value of the output needed to break-even.
Loss	This occurs when a firm’s total costs are greater than its total revenues, i.e. the business is unprofitable.
Margin of safety (safety margin)	The numerical difference between how much a business sells and its break-even quantity.
Profit	The financial surplus that remains when a firm's total costs (TC) of production are deducted from its total sales revenues (TR). Hence, profit = TR – TC.
Target price	This is the amount customers need to pay per unit in order for the firm to break-even or to reach a particular target profit.
Target profit	This is the amount of profit that a firm aims to earn within a given time period.
Target profit output	Also known as the target profit quantity, this refers to the quantity of sales required to reach the firm’s target profit.

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Unit 3.4 Key terms - Final accounts (some HL Only)

HL Only key terms are shown in italics.

Assets	The possessions owned by a business, which have a monetary value, such as buildings, land, machinery, equipment, inventories and cash.
Balance sheet	Part of a firm’s final accounts that shows the value of a firm’s assets, liabilities and the owners’ investment (or equity) in the business, at a particular point in time.
Copyrights	These intangible fixed assets give the registered owner the legal rights to creative pieces of work, such as the works of authors, musicians, conductors, playwrights (scriptwriters) and directors.
Creditors	Suppliers that allow a business to purchase goods and/or services on trade credit.
Current assets	Short-term assets belonging to an organization which will last in the business for up to 12 months, such as cash, debtors and stock (inventory).
Debtors	A type of current asset, referring to individual or business customers that owe money to the organization as they have bought goods or services on trade credit, i.e. they need to pay within 30 and 60 days.
Declining balance depreciation	A method using a pre-determined fixed percentage to calculate the fall in value of a fixed asset over its useful life.
Depreciation	The fall in the value of a fixed asset over time, mainly due to wear and tear (usage) and obsolescence.
Final accounts	These are the published accounts of an organization, made available to and used by different stakeholders, such as managers, employees, shareholders, sponsors, financiers and investors.
Finished goods	These are the final products of a business, ready to be sold to customers.
Fixed assets	The long-term assets (possessions) of an organization that have a monetary value and are used repeatedly but are not intended for resale within the next twelve months, such as property and equipment.
Goodwill	The reputation and established networks (know-how) of an organization, which adds to a firm’s monetary value.
Intangible assets	Non-physical fixed assets that are valuable to a firm’s survival and success, such as brand value, copyrights, trademarks and patents.
Intellectual property rights	Abbreviated as IPRs, these are a firm's fixed, intangible assets with a monetary value, comprised of goodwill, patents, copyrights and trademarks.
Liabilities	The debts of a business, i.e. the money owed to others, such as money owed to financiers, trade creditors, and the government (for tax).
Long-term liability	A debt owed by a business which will take longer than a year (from the balance sheet date) to repay.
Net assets	Refers to the overall value of an organization’s assets after all its liabilities are deducted. It is calculated by the formula: total assets minus current liabilities minus long-term liabilities.
Overdrafts	This financial service allows customers to temporarily take out more money than is available in their bank account.
Patents	The official rights given to a business to exploit an invention or process for commercial purposes.
Residual value	Also known as the scrap value, this is the value of a fixed asset at the end of its useful life, before it is replaced.
Retained profit	The value of a firm’s earnings after all costs are paid (including interest and tax) and shareholders have been compensated (dividends).
Share capital	The value of equity in a business that is funded by its shareholders, either through an initial public offering (IPO) or via a share issue.
Stocks	Also known as inventories, these are the goods that a business has available for sale, per time period.
Straight line depreciation	A method of depreciation that spreads the depreciation of a fixed asset evenly over its useful life, i.e. the value of the asset falls by the same amount each year.
Trade creditors	Suppliers may give trade credit, which needs to be repaid at a future date (typically 30 to 60 days).
Trademarks	A form of intellectual property, the value of which gives the listed owner the legal and exclusive commercial use of the registered brands, logos, and/or slogans (corporate catchphrases).
Work-in-progress	Also referred to as semi-finished goods, these are parts and components used in the production process.
Working capital	The money available for the day-to-day running of a business. It is calculated by subtracting current liabilities from current assets.

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Unit 3.5 Key terms - Profitability and liquidity ratio analysis

Acid test ratio	Also known as the quick ratio, this is a short-term liquidity ratio used to measure an organization’s ability to pay its short-term debts (within the next 12 months of the balance sheet date), without the need to sell any stock (inventories).
Current ratio	A short-term liquidity ratio used to calculate the ability of an organization to meet its short-term debts (within the next twelve months of the balance sheet date).
Gross profit margin (GPM)	A profitability ratio that measures an organization’s gross profit expressed as a percentage of its sales revenue. It is also an indicator of how well a business can manage its direct costs of production.
Liquidity ratios	Financial ratios that examine an organization’s ability to pay its liabilities and debts.
Net profit margin (NPM)	A profitability ratio that measures a firm’s overall profit (after all costs of production have been deducted) as a percentage of its sales revenue. It is also an indicator of how well a business can manage its indirect costs (overhead expenses).
Ratio analysis	A quantitative management planning and decision-making tool, used to analyse and evaluate the financial performance of a business. These can be further categorised as profitability, liquidity and efficiency ratio analysis.
Return on capital employed (ROCE)	A profitability ratio that measures a firm’s efficiency and profitability in relation to its size (as measured by the value of the organization’s capital employed).

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Unit 3.6 Key terms - Efficiency ratios (HL Only)

Creditor days ratio	The efficiency ratio that measures the average number of days an organization takes to repay its creditors (suppliers who the business has bought products from using trade credit, so have yet to pay for these).
Debtor days ratio	The efficiency ratio that measures the average number of days an organization takes to collect debts from its customers (as they have bought goods and services on trade credit but have yet to pay for these).
Efficiency ratio	Financial planning and decision-making tool to measure how well the resources of a business are used in order to generate income from the firm’s capital.
Gearing ratio	The efficiency ratio that measures the extent to which an organization is financed by external sources of finance (i.e. loan capital as a percentage of the firm’s total capital employed).
Stock turnover ratio	The efficiency ratio that measures the number of days it takes a business to sell its stock (inventory). The ratio can also show the number of times during any given period of time (usually a year) that the business restocks or replaces its inventory.

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Unit 3.7 Key terms - Cash flow

Bad debt	This occurs when a debtor is unable to pay outstanding invoices to the business. The result is it reduces the cash inflows for the vendor (seller).
Cash	The money a business has, either “in hand” (at its premises) and/or “at bank” (i.e. in its bank account). It is the most liquid of a firm’s current assets and is easily accessible.
Cash flow	The movement of an organization’s cash inflows (cash received from the sale of goods and services) and cash outflows (used to pay for the costs of running the business).
Cash flow	The movement of money in and out of a business organization.
Cash flow forecasting	A quantitative technique used to predict how cash is likely to flow into and out of the business for a particular period of time.
Closing balance	Found in a cash flow forecast, this refers to the value of cash held by a business at the end of a trading period (usually on the last trading day of the month).
Credit control	The process of monitoring and management of debtors, such as ensuring only suitable customers are given trade credit and that customers do not exceed the credit period.
Current assets	The short-term assets (belongings) of an organization that can be relatively easy to convert into cash. These comprise of: Cash Stocks (inventory), and Debtors.
Current liabilities	The short-term debts of a business, which need to be repaid within twelve months of the balance sheet date. These comprise of: Overdrafts Trade creditors, and Short-term loans from banks.
Debt factoring	A financial service provided to businesses that are struggling to collect money from their debtors and/face liquidity problems, involving the third party financier taking over the collection of the firm’s outstanding (unpaid but issued) invoices.
Debtors	A category of current assets, these are individuals or businesses that owe money to the organization because they have bought products on trade credit, so typically need to pay within 30 and 60 days.
Liquidity problem	Also known as a cash flow problem, this issue occurs when there is a lack of cash in the organization because its cash inflows are less than its cash outflows, i.e. it experiences negative net cash flow.
Net cash flow	The numerical difference between an organization’s total cash inflows and its total cash outflows, per time period. The formula to calculate this is: Cash inflows – Cash outflows.
Net current assets	Also known as working capital, this is shown on a balance sheet to reveal the liquidity position of a business, this is found by using the formula: Current assets – Current liabilities.
Opening balance	Found in a cash flow forecast, this refers to the value of cash held by a business at the start of a trading period (usually the beginning of the month).
Overdrafts	A financial service from banks that enable customers to temporarily take out more money than is available in their bank account.
Profit	The value of sales revenue after all costs have been accounted for, i.e. the positive difference between a firm’s sales revenue and its total costs of production.
Sales revenue	The value of goods and/or services sold to customers. It is calculated using the formula: P × Q where: P = Price, and Q = Quantity.
Short-term loans	Advances (borrowed funds) from a financial lender, such as a bank, repayable within 12 months.
Stocks	Also known as inventories, these are the goods that a business has available for sale, per time period. They are intended to be sold as quickly as possible, to generate cash for the business.
Tax	Payment made to the government if the business earns profit after all costs and expenses have been paid.
Trade creditors	The suppliers who have yet to be paid, as they offer the business to buy now but pay later, generally within 30 to 60 days from the time of purchase.
Working capital	Also known as net current assets, this refers to the cash or other liquid assets available to an organization for its daily operations, such as paying for raw materials, utility bills and staff wages.
Working capital cycle	The duration between a business paying for its production costs of a good or service and receiving the cash from customers purchasing the product.

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Unit 3.8 Key terms - Investment appraisal (some HL Only)

Note: Key terms shown in italics are HL Only

Accounting rate of return (ARR)	Also referred to as the average rate of return, this method of investment appraisal calculates the average annual profit of an investment project expressed as a percentage of the amount of invested.
Capital expenditure	A business organization’s spending on the purchase or acquisition of fixed assets, e.g. spending on buildings (premises), machinery, equipment and tools.
Discount rate	The figure used to reduce the future value of money. It is used to establish the present value of cash that is yet to be received by the business.
Investment	Capital expenditure with the intention of a financial return on this spending at some point in the future.
Investment appraisal	The formal process of quantifying the financial risks of an investment decision, in order to establish whether the expenditure can be justified from a financial perspective.
Net present value (NPV)	A method of investment appraisal that calculates the real value (rather than the absolute value) of an investment project by discounting (adjusting) the actual value of money received in the future.
Payback period (PBP)	The investment appraisal method that considers the time it takes for the amount of money invested in a project to be repaid using the proceeds generated from the investment.

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Unit 3.9 Key terms - Budgets (HL Only)

Adverse variance	This discrepancy in the budget occurs when profit is lower than expected, due to costs being higher than expected and/or revenues being lower than predicted.
Budget	A detailed financial plan for the future, usually involving the expected costs and revenues or a cash flow forecast, for a pre-determined period of time.
Cost centre	A section or division of a business that has responsibility for its own operational costs. It is held accountable for its departmental expenditure.
Favourable variance	This discrepancy in the budget occurs when profits are higher than expected, due to lower than expected costs and/or higher than predicted revenues.
Profit centre	A section or division of a business that has responsibility for both costs and revenues generated within the department. It is held accountable for the amount of profit generated.
Variance	Refers to a discrepancy between the planned (budgeted) item of expenditure or revenue and the actual amount.
Variance analysis	This is the management process of comparing planned and actual costs and revenues, in order to measure and compare the degree of budgetary success.
Zero budgeting	A method of budgeting that requires all budget holders to justify each dollar of spending subject to management approved before the funds are released.

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Unit 3 Key terms - Finance & accounts

Unit 3 Key terms - Finance and Accounts

Unit 3.1 Key terms - Source of finance

Unit 3.2 Key tems - Costs and Revenues

Unit 3.3 Key terms - Break-even analysis

Unit 3.4 Key terms - Final accounts (some HL Only)

Unit 3.5 Key terms - Profitability and liquidity ratio analysis

Unit 3.6 Key terms - Efficiency ratios (HL Only)

Unit 3.7 Key terms - Cash flow

Unit 3.8 Key terms - Investment appraisal (some HL Only)

Unit 3.9 Key terms - Budgets (HL Only)