Unit 5 Sample Answers

Essential Business Studies for Cambridge IGCSE® and O Level

Sample Answers to Practice questions

Unit 5 Financing business activity

Section 1: Short-answer questions

1. Finance may be used by a business in the many ways, including:

Start-up capital
Ongoing ‘cash flow’ as money flows in from sales and goes out to pay costs
Finance for expansions, such as from shareholders or bank loans
Understanding of uses of finance [3]

2. A new bakery business may have start-up costs that have to be paid, such as rent in advance.
There will also be a time lag before any cash comes into the business because it may take time
to produce and sell products. However suppliers need to be paid now and so does labour.
Two reasons plus explanation [4]

3. Microfinance lenders typically loan small amounts of finance to individuals or groups to start
small enterprises (seed money). Typically these borrowers would not be able to source finance
elsewhere. Grameen bank is an example. Amounts are small and interest is payable.
Two reasons plus explanation [4]

4. Owner’s savings is an important sources of finance for a new entrepreneur because it is money
that they already have which can be used as start-up capital, attracts no interest and does not
need to be repaid. Other lenders, such as banks, are also more likely to lend to an entrepreneur
who has invested their own money.
Explanation of owner’s savings as a source of finance [3]

5. Sales revenue – total costs [variable costs plus overheads] = profit [2]
OR Gross profit – expenses = profit

6. Cash and profit are not the same and hence it is possible for a business to have cash available
but not to make any profit. The reasons for this are that it might have an overdraft with the
bank that gives it access to cash on a daily basis. It also may have overhead costs that are paid in
arrears at the end of the year. Also some costs of a business are things like depreciation of
assets that do not actually result in cash outflows but which are included in the calculation of
profit.
Two reasons plus explanations [6]
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7. Gross profit is sales revenue – cost of sales. Profit is gross profit – overheads. For a small retail
business the difference would be that gross profit is the sales revenue – the cost of the stock
sold. While calculation of profit would take into account other costs like rent/ rates / insurance/
electricity
Explanation plus examples [4]

8. If profit is retained by a business the amount distributed in the form of dividends will go down.
To a shareholder, dividends represent an income. So retained profits reduce their income.
However if profits are retained the business will have capital to invest and grow in the future.
This might mean higher profits next year. So in the future the shareholders may gain more.
[share price might also rise]The issue is about when the shareholders actually benefit from the
profits of a business.
Explanation of issues affecting the decision [4]

9. Trading profit = gross profit – overheads

Retained profit = trading profit – profit distributed [dividends]
Two formulae [4]

10. Profit is the reward for successful risk taking. The owners of a business invest their capital in the
business. No return is guaranteed. So profit is necessary to encourage them to invest in the first
place and to reward them for doing so. If there were no rewards then no one would set up a
business and then there would be no companies and no products and no employment.
Anticipated profit is an incentive to owners and hence is an important reward.
Two reasons plus explanations [4]

11. A business will produce an income statement at the end of every trading year. Thus, it will be
possible to compare year on year figures for sales, costs and profit, in order to work out
percentage change and compare with financial objectives.
Explanation [4]

12. Non-current assets are assets that the business owns on a long term basis. Current assets are
assets held on a short term basis. Examples of non-current assets would be premises /
machinery and equipment. Current assets examples would be inventories accounts receivable
and cash in the bank.
Explanation plus examples [4]

13. A lender wants to be sure that the borrower will be able to pay back the loan. The balance sheet
of a business shows what a business owns [assets] and what is owes [liabilities]. So if a business
has few assets and it already has high debts it will find it difficult to repay any further loans. A
prospective lender would look at the balance sheet of a business to assess the risk it would be
taking in lending any more capital to the business.
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Understanding and application to balance sheet [4]

14. The current ratio of a business is calculated by current assets/current liabilities. Acid test ratio is
calculated by current assets – inventories/current liabilities. So the difference is that the current
ratio includes stock but the acid test does not. Both ratios try and measure the liquidity of a
business by assessing how easily a business can turn its assets into cash to meet short term
debts [current] Acid test ratio is thought to be a better measure of liquidity because inventories
are the most difficult asset to convert in the short run A clothes shop could only shift its
inventory quickly if it reduced its prices so low that it was sold at a loss.
Explaining the two ratios plus application [4]

15. Calculations produce the following results

2012 Gross profit = $60000 Profit = $40000
2013 Gross profit = $60000 Profit = $35000

The gross profit and profit margins for the two years are thus
2012 Gross profit margin = 60% : profit margin 40%
2013 Gross profit margin = 54.54% : profit margin = 31.8%

One mark per correct calculation [8]

16. The question requires interpretation of the figures presented. A discursive answer about what
success implies would gain up to 2 marks. The revenue of the business increased by $15000 in
2013. This would be regarded as an improvement in performance. [an increase of 15%] Gross
profit stayed the same at $60000 but the profit overall fell by $5000 [$40000 - $35000] This
would be regarded as a weaker performance. Both gross profit margin and profit margin fell in
2013. Both indicate a worsening of the performance of the business. The fall in the margins
suggest that the increase in business costs exceeded the increase in revenue/ So the data
suggests that performance in 2013 was less satisfactory than in the previous year.

Identification of relevant figures [2] / analysis of figures [2] / conclusions based on analysis[2]
[6]
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Section 2: Longer-answer questions

Blooms – Flowers for all Occasions

1. The cash flow table given appears to contain an error, well done if spotted! In Feb, the cash
available should be $1000 plus balance brought forward from Jan ($150). So cash available
should be $850, not $1350 as shown.
Given this apparent error the figures look as follows:
$’s
Feb March April May June
Balance b/f (150) (1550) (1950) (1850) (1250)
Total Receipts 1000 3000 4000 5000 4000
Total cash available 850 1450 2050 3150 2750
Purchases 500 1500 2000 2500 2000
Total Payments 2400 3400 3900 4400 3900
Balance c/f (1550) (1950) (1850) (1250) (1150)

2. Cash flow problems occur when cash out in a month is greater than cash in. This seems to be the
case in both January and February. The peak of ‘overdrawn’ is March with $1950. After that
month the negative balance declines.
Two months identified [2]

3. Yes, I think that the bank should lend money to the business because the business is basically
sound but has periodic short term cash flow problems. An overdraft facility would meet the
needs of the business perfectly. The cash flow problems are caused by the seasonality of sales of
a flower business whose market is based on festivals and special occasions.
Consideration and analysis of factors in context [4]

4. A cash flow problem can be improved either by altering the amounts of cash flowing in and out
of the business or by changing the timing of the cash flows. In this case the best chance would
appear to be altering the timing of flows. Grace should negotiate credit terms with her suppliers
so that cash is paid a month or so after delivery of stock. Similarly Grace could try and alter the
timing of her rent payments or perhaps encourage customers to pay her in advance of her
ordering stocks. Perhaps the best way of improving the cash flow would be to reduce the
amount of stocks of flowers she holds. This would reduce her working capital needs and
improve the cash flow.
Two methods explained in context [4]

5. Gross profit = $24000. Net profit = $4000. [4]

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6. Gross profit margin = Gross profit/sales% = 24000/48000 = 50%

Profit margin = profit/sales% = 4000/48000 = 8.3%
Formulae plus calculation [4]

7. If cost of inventories increases by 10% then cost of sales = $26400. Assuming these costs are not
passed on in the form of higher selling prices, the gross profit of the business now =
$48000 - $26400 = $21600. Gross profit margin = 4.5%
Net profit = $1600, so net profit margin = 3.3%
Formulae plus calculations [6]

8. Current assets of a business are inventories + debtors + cash. In the case of this business, a large
amount of flower inventories are held daily. Current liabilities are short term debts owed by the
business to its creditors. These might be unpaid bills for stock that Grace has bought or perhaps
interest costs on an overdraft facility.
Explanation in context [6]

9. Net current assets = current assets – current liabilities

$10000 - $8000 = $2000
Formula plus calculation [2]

10. Current ratio = current assets/current liabilities

$10000/$8000 = 1.25
Formula plus calculation [3]

11. Acid test ratio = current assets – inventories/ current liabilities

$4000/$8000 = 0.5

Formula plus calculation [4]

12. The liquidity of a business refers to the ease by which a business can acquire cash in order to
meet its short-term liabilities. Current assets are those assets that can be turned into cash
quickly. Current liabilities are those debts that need to be paid shortly. So the net current assets
show that the business has sufficient current assets to meet its current liabilities ($10000 -
$8000 = $2000).
The current ratio expresses this relationship as 1.25. In other words the business has $1.25 short
term assets for every $1 worth of short term liabilities. This suggests that the business has an
adequate liquidity position. However the acid test ratio (as shown in answer to question 11)
shows that the liquidity of the business is not in quite such a strong position.
Analysis plus judgement [4]
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13. The acid test is a tougher measure of liquidity for a business because it excludes the value of
inventories. For this type of business it would be a more appropriate measure because the
inventory of this business is flowers and this inventory is highly perishable. Indeed it may not be
very liquid at all because if sales fell the inventory would be valueless. So to regard this
inventory as being of potential value would be misleading. It is always recognised that inventory
is the least liquid of all current assets held by any business. In the case of highly perishable
inventory this is especially the case. The current ratio would overstate the liquidity position of
the business.
Consideration and analysis of points plus conclusion [6]

14. The suppliers of a business are interested in the accounts primarily because they want to know
if and when they will get paid for the goods they provide. The current ratio and cash in hand will
help them assess this. If Blooms was a new start-up business the suppliers would be reluctant
to supply goods on credit.

Customers might be interested in the accounts because they would be able to assess the size of
the business they are going to buy from. Blooms supplies flowers for weddings and for their
customers this is a very special event. They would wish to buy from an established and reliable
business so that they can be sure that the flowers will be delivered on time and be of good
quality. A profitable and successful business gives them that sort of assurance.

The employees of a business are interested in the accounts because it shows them how
profitable the business is and hence how potentially secure their jobs are. They might also be
interested in the profits because this might indicate whether the business could perhaps afford
to increase their wages. However in the case of Blooms only one trainee is employed so their
interest in the accounts would be minimal.
Explanation [3 for each stakeholder] [9]