Business Finance and Accounting
This domain tests matching sources of finance to needs, and recording transactions accurately using the accounting equation and final accounts. Expect questions distinguishing capital from revenue expenditure, short-term from long-term finance, and profit from cash.
Core rules
- Internal sources: retained profit, sale of surplus assets, owner's capital. External sources: bank loans and overdrafts, trade credit, leasing, hire purchase, share capital, debentures, microfinance and government SME loan schemes.
- Match the term of finance to the life of the asset: overdraft for stock, a long-term loan for buildings and machinery.
- Working capital = current assets − current liabilities; it funds day-to-day operations.
- Accounting equation: assets = liabilities + capital. Every transaction keeps it balanced through double entry.
- Income statement shows profit = revenue − expenses for a period. The statement of financial position shows assets, liabilities and capital at a date.
Worked example
A trader's assets are K850,000 and liabilities K300,000, so capital = K550,000. She then buys a freezer for K100,000 on credit. Reasoning: the freezer increases assets by K100,000 to K950,000; the supplier debt increases liabilities by K100,000 to K400,000. Capital is unchanged because no profit, loss, drawing or new capital arose. Check: 950,000 = 400,000 + 550,000. If she had paid cash instead, assets would merely swap (equipment up, cash down) and total assets would stay at K850,000.
Traps that cost marks
- Treating drawings as a business expense; drawings reduce capital.
- Assuming a profitable firm cannot run out of cash - credit sales create profit without cash.
- Recording a credit purchase in one account only.
- Treating the whole loan repayment as an expense; only interest is an expense, the rest reduces the liability.