( 25 )育教日一十月三年未辛麿
1991中學會考預習專關
MIEL & DALL. PRESS
Capital and Business Finance
-Studying Areas
Commerce (30)
The main studying areas in this unit include:
a. importance of capital
b. forms of capital,
c. meaning of capital gearing,
d. methods of obtaining capital,
e. analysis of the financial statements of a business firm,
f. measures of the profitability of a firm,
d. methods of increasing the level of profits, and
h. rate of turnover and its importance.
II. Importance of capital.
The business capital of a firm is the money available to finance its running. The sources of the money may be supplied through the following ways:
(a) self finance by owners,
(b) reinvestment of retained profits. by the business firm, or (c) external borrowings from banks.
With the efficient use and allocation of capital resources, the business firm acquires the capital to achieve the following purposes:
(a) to buy fixed assets such as buildings and machinery..
(b) to buy trading stock ́and then for resale,
(c) to finance its day-to-day operation,
(d) to strengthen the financial capability of repaying its
short-term or immediate debts.
111. Forms of Capital
The capital of a business can be divided into four kinds a. Fixed capital
Fixed capital refers to those capital tied up in permanent fixed assets, which are bought for continuous use in the business on a permanent basis. Examples include buildings, machinery and motor vehicles. The nature of fixed capital is immobile.
Working capital
Although a large portion of the money may be required to buy fixed assets. a business firm must have sufficient working capital to run the business. The working capital: can be used in the following:
to buy materials to be made up into finished goods,
1. to purchase stock to sell to customers, iii. to meet its day-to-day running expenditure,
for.
example, payments of rent, insurance, salaries and creditors, etc.
The formula for measuring working capital is
Current Assets Current Liabilities Working Capital To run short of this capital is the common cause of business failure,
The working capital ratio is always used to measure the ability of a firm to meet its short term or immediate debts. The formula for the working capital ratio is:
Current
Assets
work
Current Liabilities
Working Capital Ratio A
What is acceptably safe ratio of working capital?
The least minimum ratio is commonly accepted to be 2 Liquid.capitalis
Ciquid capital refers to those assets that are availablas
cash, or bank, or any assets that can easily be forned into cash (near cash)
The liquid capital ratio is more better that
ratio when the capability of a hiisiness. Immediate debts is assessed.
capital
its
The liquid capital ratio is to be calculated as follows:
Liquid Capital Ratio =
Current Assets Stock
Current Liabilities
In order to meet its immediate debts, a firm should seek to Find outside sources of borrowing when it runs short of liquid capital,
d. Capital employed
Capital employed is a measure of the toets which are being used in a business firm, whether borrowed or not.
It takes two main forms;
Gross capital employed Total Assets
ii. Net capital employed Total Assets:- Debt Owing
IV. Meaning of capital gearing
The term refers to the indication: of the capital coportion. between the debentures issued and the various types of shares which. a limited company raises to finance operation. Leverage is another term for this: expression.
Capital Gearing Ratio=
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borrowing. The temporary cashflow problems can be solved. in this way.
b. Trade credit from suppliers
In order to generate the increased sales, suppliers are willing to offer trade credit facilities to business firms. In doing so, the firms can enjoy the interest-free grace period while the payment is being made at a later. date.
Factoring arrangement
The function of a factoring company is to take over the trade debts of firms, Most of the firm's capital are usually tied up in the form of trade debtors if the firm sells goods on credit to its customers. The Factor can ease temporary cashflow problems by converting the debts owing into cash. By Factoring of debts, the selling- companyes not have to wait for "payment from the. customers. A factor is always linked to finance company to finance the working of the fattoring of debts. d. Loans from family, relatives, friends от business
associates
Analysis of the Financial Statements of a Business Firm Financial statements are summary reports of the financial position of a business firm. These include balance sheets as. well as trading and profit and loss accounts.
1. Analysing the balance sheet
A balance sheet is a financial statement in which the accounting equation (Assets Owners Equity + Liabilities).
is expressed at a particular date.
Its use is to show the financial condition of what the firm owns and what it's owes.
Assets are all those items that the business firm owns, which have monetary value.
Liabilities are all debts that the business firm owes." Owners' Equity je the amount that the business owes to 135 owner(s).
Traditionally, the horizontal format of balance sheet sole trader is shown as follows:
Mr Cheung
Balance Sheet as at 31 December 1990
Notes
(c) Capital
Fixed Assets
S. (a)
Balance as at 4.1.19
150,000 Premises
100,000
Fixtures & Fittings
50,000
Add Net profit
60,000 Motor vehicles
50,000
210.009
Less: pawings
10,000, Current Assets 200,000 Stock
30,000
Bank
20,000
.Cash
for the year
(a) Long-term Liabilities Pebtors
Llabîtitles -
(e). Current
Bank Loon
Liabilities
Back verdraft
Trade creditors 25,000 39.000
The notes are briefly explained below: (a) Fixed Assets
$300,000
These are those parma lent assets which were bought for continuous use e firm. They avesveseful life extending over a
Examples include" Verdes, etc.
(b) Current Assets
wood and are calor
fixture
sale.
ngs, motor.
These are those assets, which are expected to be realiser within one year. They are often called liquid asset Examples include stock, debtors, bank and cash.
(c) Capital
Capital is the liability of the business firm to its owner.
Owners equity, net assets and net worth are another expression for capital.
Liabilities are divided into two classes; long-term Liabilities and current liabilities.
(d) Long-teru Liabilities:
These are debts, loans and ether amounts borrowed by the firm
They are falling due for repayment more than one year. (e) Current Liabilities
These are any money owed by the firm. The depts are falling due for repayment within one year.
2. Analysing the Trading and Profit and Loss Account
A business firm aims to make profit.
In what ways do the firm show the operating profits for the.
year? ways do the f
The account includes two sections:.
The trading account, which is used to calculate the gross profit or gross loss on trading during the accounting year. The profit and loss account, which shows the new profit for the financial year, ver
四期 日五廿月四(一九九一)年十八國民華中
日一十月三年未
(b) Return on capital employed or return on equity
This ratio indicates how much, the firm earns on the capital employed and how efficiency the
shareholders' funds.
Its formula is:
Net profit Capital employed
Firm ufilies. thes
X 100% Return on equity.
The low return on equity gives some indication on the potential investor as to whether he would invest his capital in other firms with a view of earning more profits.
VIII.Methods of increasing the level of profits
The year-to-year comparision of the profit. figures can reveal the possible causes of the rising and falling of net profit.....
The ways of increasing net profit include:
(a) reduction of operation;expenses
The expenses could be decreased by: 1. reducing the number of workers, ii. moving the cheaper site of business, iii, reducing the
and range
facilities,
level of servicing
advertising,
iv. reducing costs such as lighting,
introducing computerization.
Once the running expenses have kept under control, the
total expenses can be decreased.
(b) reduction of the cost of goods sold
The cost could be decreased by:
1. improving the standard of storage facilities..
11. buying in bulk with a view of gaining special. ...discounts;
111 changing to supplier of offering at lower prices. The level of gross profit tends to increase if the cost of goods sold falls and the sales turnover remains constant.
(c) generating the increased sales turnover
The increased sales turnover.could be achieved by:
1.
Taunching bf promotion package such as sales promotion, and diversified advertising,
providing better and wide ranges of servicing facilities,
iii. lower prices with a view of stimulating higher
demand,
iv. stocking goods of a high demand,
V. broadening the range of goods sold..
However, the increased sales turnover may be outweighed by a higher increase of the running expenses arising from the introduction of the above policies. Thus, the firm should exercise better management control over the attainment of increasing the net profit.
(d) ploughing back or reinvesting of net profits
Ploughing back can be regarded as the efficient means
of expanding and updating productive capacity by buying additional machinery.
Rate of Turnover-
1 Its meaning and calculation
The turnover of a business firm is another expression for its total sales over a given period of time,
The net turnover is the value of sales minus any goods that have been returned (net sales) in a given period of time. The rate of turnover (or rate of stockturh) measures the number of times the average of stock of a firm is sold in
yeas. It also shows how quickly the average stock is.
nga given period of time, which is usually a year.. Speed so the stock turnover ratio is to increase the
ss profits.
Methods of calculation can be used:
(a) The rate of turnover - Average Stock at Selling Price
Net: Turnover
(b) The rate of turnover =
Cost of Goods Sold Cost of Average Stock# Opening Stock + Closing Stock
Average stock Tiation: If a firm has a turnover of $600,000. In one year with its gross profit of 10%, as well
as the opening stock, and closing stock are respectively $100,000 and $300,000.
To calculate the rate of turnover.
lacking: Cost of goods sold = $600,000 - $600,000 × 10%
LIBRARIE
It is prepared once a year for annual report to investors.or Owner. However, it may be prepared monthly, quarterly half-yearly for internal managerial control. Traditionally, the format of the trading a profit. account of a sole trader is shown below:
KON
The formula for measuring capital gearing ratio is:
Fixed Interest Securities.
Total Capital Preferences Shares+Debentures+Loans
Total Capital
If the firm has a highly-geared capital, it means that a Targe portion of its capital is comprised of preferences shares and debentures: This implies that a large portion of fund should be paid out in the forms of fixed interests or dividends to the owners of preference shares and debentures before the ordinary shareholders can receive their dividends.
Methods of Obtaining Capital
1. The Sources of Long-term Capital.
A business firm can obtain its sources of long-term capital to finance the expansion or large. projects through the following ways;
a. Ploughing back
Some portion of uridistributed profits may be reinvested in the firm. The funds are interest-free as it would have to do on a business loan. Ploughing back is seen us an efficient way of upgrading as well. 35 expanding productive capacity by purchasing advanced equipment. b. Self finance
The owners of the sole proprietorship or partnership.can invest their personal savings so as to increase the capital of the business. Moreover, a source of capital can be created by using some or all of the retained profits earned by the owners in the firm.
c. Admitting new partners.
Shares of the firms could sell, to new partners in return. for additional capital,
d. Long-term bank finance
A fixed sum of bank loan can be arranged for long-term. borrowing by the firm,
Mertiging is another form of long-term loan against, Which the real estate owned by the firm is used as
security.
e. Buying on hire purchase-
Using hire purchase, the firm can enjoy the immediate use of goods, while payment is being made later.
f. Issuing debentures or shares
A Firm can obtain finance by issuing debentures, which are lung-term interest-bearing certificate loans, to investors. The principal of long-term loan is to be paid upon maturity. By selling ownership shares to the public, the public limited companies can raise more capital.
9. Leasing or renting
Instead of buying equipment or real estate, a firm can arrange leasing agreement to choose the fixed assets best. suited to its needs. Within the leasing period, the firm can enjoy the immediate use of the assets with the mere payment of a fixed leasing fee.
Although the user. never owns the assets, the first lease would be replaced with the more advanced asset 1 t the firmi continually requires a new model. Moreover, it is the responsibility of the leasing company to undertake the repairs and maintenance of the assets.
Using the leasing agreement, the lessee May save the initial large sum of capital expenditure if the assets would be purchased outright.
2. The Sources of Short-term Capital
The main sources of raising short-term working capital to finance its day-to-day operating expenses by a firm are as follows:
a. Bank overdrafts or advances
A firm can obtain bank overdrafts as a form of short-term
Br Cheung
PUBLIC
Open Stock
Aud Purchases
25,000 Balas 275,000 100,000 30,0
Less Closing Stock (b)cast of Goods 3014 74.0 (c)Gross Profit' c/c: 130,000
(d)Operating Expenses.
salaries
Janu
Grass Profit 35,000 b/d 10,000 Electricity & Water 16,000
Sundry expenses
10,000.
60,000 130,00%
talker profit
Notes
200,000 (a)
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100.000
ተሰ
The notes are briefly explained below:
(a) Sales
It is a technical term, Sales means the sale of those items in which the business firm usually deals and were! purchased with the prime. motion of resale. They) represent the sum of all gross earnings produced by the sales of goods or services in the period,
(b) Cost of Goods Sold
It represents the total cost prices of goods sold in the period.
The equation is:
Opening Stock Purchases-Closing Stock-Cost of Goods
Sold
(c) Gross Profit
It is the difference between the sales and the cost of goods sold.
The equation iş:
Sales Cost of Goods Sold = Gross Profit
(d) Operating Expenses
These are the day-to-day running expenditure which have been consumed during the accounting period.
Examples include: salaries, rent electricity. & water, and sundry expenses, etc.
(e) Net Profit or Loss
The net profit is the difference between the gross -profit and all the operating expenses for that
particular period,
The equation is:
Gross Profit - All Operating Expenses Net Profit
VII. Measures of the profitability of a firm
In what ways do the firm give indication of earning a reasonable profit?
The following two methods have been used to measure the profitability of a firm:
(a) Percentage profit
It is meaningful to calculate the gross ar net profits as a x. percentage of sales or turnover.
Its formula are:
Gross profit percentage =
Net profit percentage
=
Gross Profit
Sales Net Profit
Sales
X 100%
x 100%
For example, if the sales was $100,000, and the net profit was $40,000, the net profit percentage was:
$40,000
$100,000 × 100% = 40.0%
This indicates that for every dollar of sales, it would This ratio measures the generate a profit of 40 cents. returns on sales and give hint on the efficiency of a firm.
Average stock
Rate of turnover
$600,000 $60,000 $540,000
($100,000 + $300,000).
= $200,000,
Cost of Goods Sold
Cost of Average Stock $540,000
$200,000 =2.7
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This figure shows that the average stock has been sold
2.7 times over a given year.
The stockturn ratio can be expressed in months or în days by the following formilai
(a) To express the figure in months: Stockturn
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x months
{b} To express the figure in days:
365 Stockturn
x days
In doing so, we can calculate on average how long we keep the average stock before we sell it From the above example, stockturn (in months) = 7
5.0 months Stockturn (in days) = 27 365
= 136 days
2. Importance of the rate of turnover
The rate of turnover will be varying from industry to industry, from firm to firm. However, it is important and useful to compare with rates:
(a) of other firms selling the same kind of goods, (b) for previous performance of the trading year. 3. Factors that influence the rate of turnover
Different kinds of goods may have different stockturo.
The influential factors are explained below: (a) Value of goods
rates: of
The expensive item of furniture is associated with a low stockturn because the highly value durables keep in stock for a long time and sell slowly.
(b) Nature of goods
Perishable goods is associated with a high stocktúra because the seller has to deal in the fresh fruit, vegetables or newspapers quickly. They cannot remain in stock for long. (c) Level of demand
A low stockturn is associated with sellers of high consistent level of demand for goods. Examples of such goods include daily commodities such as rice and bread. There are two methods of increasing the rate of tornover:
(a) to generate the increased sales turnover by Tower
prices,
sales promotion, offering after-sales servicing and credit facilities to customers, and (b) to decrease the level of stock by better inventory
control.
Self-assessment question
1. Why does the business firm need capital?
2. What are the functions of the working capital in a firm?
3. (at what is meant by the term "capital gearing"?
(b) Explain the term "highly-geared capital" used in the
capital market.
4. Briefly describe the sources of long-term capital in à firm, 5. Outline the sources of short-term capital in a firm.
6. Briefly describe the methods of increasing the level of
profits.
7. (a) In what way does a firm calculate the rate of turnover?
(b) What are the factors that influence the rate of
turnover?
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