Finance and accounting for business
What the exam tests
You must identify sources of finance, interpret the income statement, balance sheet and cash-flow statement, calculate break-even and simple ratios, and explain why profit differs from cash.
Core rules
- Sources of finance: internal (retained profit, sale of assets, working capital reduction) and external (bank loan, overdraft, trade credit, leasing, equity, grants). Short-term finance covers day-to-day needs; long-term finance funds assets and expansion.
- Income statement shows revenue, costs and profit over a period. Balance sheet is a snapshot of assets, liabilities and equity at a date. Cash-flow statement explains cash movements.
- Break-even = fixed costs ÷ contribution per unit, where contribution = selling price − variable cost per unit.
- Ratios: gross profit margin, net profit margin, current ratio (current assets ÷ current liabilities), acid-test ratio (excluding inventory), gearing (debt ÷ capital employed).
- Depreciation spreads the cost of a non-current asset over its useful life; it is a non-cash expense.
- Working capital = current assets − current liabilities.
Worked example
A workshop has fixed costs of €30,000, sells a product at €10 and has variable cost €4 per unit. Calculate break-even and the sales needed for €12,000 profit. Reasoning: contribution = €10 − €4 = €6. Break-even = €30,000 ÷ €6 = 5,000 units, or €50,000 revenue. For €12,000 profit, required units = (€30,000 + €12,000) ÷ €6 = 7,000 units. If actual sales are 6,500 units, margin of safety = 1,500 units above break-even. The calculation assumes constant price and variable cost per unit, which is a limitation.
Traps that cost marks
- Treating profit as cash; a profitable firm can fail if customers pay late.
- Mixing up the balance sheet date with the income statement period.
- Forgetting that break-even includes fixed costs but not target profit unless asked.
- Including inventory in the acid-test ratio.
- Treating depreciation as a cash payment.