Finance

What Finance covers

Finance is examined in Component 02, Operations, finance and external influences. It covers the finance function and business failure, assets, liabilities and capital, cash, profit and working capital, cost behaviour and sales revenue, contribution and the break-even point, break-even charts and the margin of safety, using contribution to make short-term decisions, levels of profit and profit margins, budgets and budget setting, budget variances, cash flow forecasting and its uses, the structure of a cash flow forecast, remedies for a cash flow shortage, liquidity, the current ratio and the acid test, retained profit, owners' investment and asset sales, loans, overdrafts and other debt finance, share capital, venture capital, crowdfunding and grants, choosing a source of finance, financial statements and who uses them, the income statement, the statement of financial position (balance sheet), return on capital employed and gearing, inventory turnover, receivable days and payable days and ratio analysis and its limitations.

The 24 subtopics

Each one has its own page.

• The finance function and business failureRecall questions on what the finance function does, the information it supplies to managers and outside users, the dangers of poor financial records, and insolvency, administration, liquidation, bankruptcy and the warning signs of failure.Open →
• Assets, liabilities and capitalRecall questions on non-current and current assets, current and non-current liabilities, share capital and retained profit as equity, calculating net current assets, net assets and total equity, and ranking assets by liquidity.Open →
• Cash, profit and working capitalRecall questions on the difference between cash and profit, why a profitable business can run short of cash, how credit sales, asset purchases and loans affect each, calculating working capital, and overtrading.Open →
• Cost behaviour and sales revenueRecall questions on fixed and variable costs with examples, the formulas for total cost, total revenue and unit cost, calculating costs, revenue and profit, and why fixed cost per unit falls as output rises.Open →
• Contribution and the break-even pointRecall questions on contribution per unit and total contribution, calculating profit and break-even output, how changes in fixed costs, variable costs and price move the break-even point, and output needed for a target profit.Open →
• Break-even charts and the margin of safetyRecall questions on reading a break-even chart, its axes and fixed cost, total cost and total revenue lines, the profit and loss areas, calculating the margin of safety, and how the chart shifts when costs or price change.Open →
• Using contribution to make short-term decisionsRecall questions on judging special orders by contribution, discontinuing an apparently loss-making product, the lowest acceptable price, how changes in sales and variable costs affect profit, and the assumptions and uses of break-even analysis.Open →
• Levels of profit and profit marginsRecall questions on gross profit, operating profit and profit for the year, cost of sales, expenses and finance costs, calculating each profit margin, the difference between profit and profitability, and comparing margins fairly.Open →
• Budgets and budget settingRecall questions on budgets and how they help a business plan, allocate resources, coordinate, control, motivate and measure performance, incremental and zero-based budgeting, delegated and imposed budgets, and the drawbacks of budgeting.Open →
• Budget variancesRecall questions on what a variance is, what makes one favourable or adverse, calculating revenue and cost variances, and how a business acts on them.Open →
• Cash flow forecasting and its usesRecall questions on the cash flow forecast, how it differs from an income statement, how it warns of trouble early, and why a lender asks for one.Open →
• The structure of a cash flow forecastRecall questions on cash inflows and outflows, calculating net cash flow and opening and closing balances, reading a forecast with a negative net cash flow or closing balance, and why credit sales and depreciation are treated as they are.Open →
• Remedies for a cash flow shortageRecall questions on remedies for a cash flow shortage, including cost control, inventory management, delaying supplier payments, selling assets, sale and leaseback, delaying investment and overdraft facilities, and the risks and limits of each.Open →
• Liquidity, the current ratio and the acid testRecall questions on liquidity and why it can matter more than profit, the current ratio and the acid test, calculating both, and how to read the results.Open →
• Retained profit, owners' investment and asset salesRecall questions on internal sources of finance, retained profit and its advantages and drawbacks, owners' investment from personal savings, selling assets and sale and leaseback, and why owners often prefer internal finance.Open →
• Loans, overdrafts and other debt financeRecall questions on bank loans and collateral, overdrafts, leasing, trade credit and credit cards as business finance, their advantages and drawbacks, and the principle of matching a source of finance to its use.Open →
• Share capital, venture capital, crowdfunding and grantsRecall questions on share capital and rights issues, the difference between dividends and interest, venture capital, crowdfunding and grants, which businesses can use each, and their advantages, drawbacks and risks.Open →
• Choosing a source of financeRecall questions on the factors that decide a source of finance — cost, flexibility, control, the size of the sum and what it is for.Open →
• Financial statements and who uses themRecall questions on what the financial statements are, why a company must produce them, and what a lender, a shareholder and the tax authority each look for.Open →
• The income statementRecall questions on the lines of an income statement from revenue and cost of sales to expenses, finance costs, taxation and profit for the year, calculating gross profit, profit for the year and retained profit, and its limitations.Open →
• The statement of financial position (balance sheet)Recall questions on the statement of financial position, its non-current and current assets, current and non-current liabilities and equity, calculating net current assets, net assets and total equity, and what the snapshot fails to show.Open →
• Return on capital employed and gearingRecall questions on return on capital employed and capital employed, calculating and improving ROCE, the gearing ratio and how to calculate it, the dangers and deliberate use of high gearing, and ways to reduce it.Open →
• Inventory turnover, receivable days and payable daysRecall questions on efficiency ratios, calculating inventory turnover, trade receivable days and trade payable days, interpreting and improving each figure, and working out how long cash is tied up in the trading cycle.Open →
• Ratio analysis and its limitationsRecall questions on why businesses use ratios, the four families of financial ratio, which ratios banks and shareholders use, window dressing, accounting policies and external conditions, and non-financial measures used alongside ratios.Open →

What you need to know

Answer each one before you reveal it.

Take Finance further

The same content, four other ways.

Commonly confused

Pairs that lose marks when they are blurred together.

• Cash vs Profit

  Cash: the money a business holds and can spend immediately, as notes and coins or in its current account. Profit: the amount by which a period's revenue exceeds the costs of earning it.

• Gross profit vs Operating profit

  Gross profit: what is left from revenue once the direct cost of the goods sold has been deducted, before any overheads. Operating profit: what is left from revenue after both the direct cost of the goods sold and overheads such as rent, marketing and salaries have been deducted, before finance costs and tax.

• Current ratio vs Acid test ratio

  Current ratio: everything a business owns that can be turned into money within a year, divided by the debts it must settle within that year. Acid test ratio: short-term assets excluding inventory, divided by the debts due within a year, so it shows whether those debts could be met without selling stock.

Questions from this topic

Each one with the model answer underneath.

1. 1

   What is the main job of a business's finance function?

   Model answer

   It records and controls the money moving through the business and turns that data into information owners and managers can act on.

2. 2

   State two kinds of financial information the finance function supplies to managers.

   Model answer

   It supplies costs and revenues for each product or department, and cash flow forecasts showing when money will be tight.

3. 3

   How does the finance function support business planning?

   Model answer

   It costs the plan by turning objectives into budgets and forecasts, so managers can see whether the business can afford what it intends to do.

4. 4

   Why do decisions improve when a business's financial records are accurate?

   Model answer

   Choices about pricing, investment and which products to keep all rest on reported costs and revenues, so wrong figures produce confident but wrong decisions.

5. 5

   Name three users outside a business who rely on the information its finance function produces.

   Model answer

   A bank considering a loan, HM Revenue and Customs, and shareholders.

6. 6

   Why is a bank reluctant to lend to a firm that keeps poor financial records?

   Model answer

   It cannot judge whether the firm generates enough cash to meet the repayments, so the loan looks far riskier and is refused or priced higher.

What is inside Levo

Six ways to work the same material.

Finance revision questions

What does Finance cover in OCR A-Level Business (H436)?

24 subtopics: the finance function and business failure, assets, liabilities and capital, cash, profit and working capital, cost behaviour and sales revenue, contribution and the break-even point, break-even charts and the margin of safety, using contribution to make short-term decisions, levels of profit and profit margins, budgets and budget setting, budget variances, cash flow forecasting and its uses, the structure of a cash flow forecast, remedies for a cash flow shortage, liquidity, the current ratio and the acid test, retained profit, owners' investment and asset sales, loans, overdrafts and other debt finance, share capital, venture capital, crowdfunding and grants, choosing a source of finance, financial statements and who uses them, the income statement, the statement of financial position (balance sheet), return on capital employed and gearing, inventory turnover, receivable days and payable days and ratio analysis and its limitations. Each one has its own page with questions and model answers.

How is Finance organised?

By the OCR H436 specification, subtopic by subtopic, so it matches the order you are taught it in.