O Level Revision : Commerce - Capital, Finance and Profit of Business

Capital,  Finance  and Profit  of Business

• Capital comprises of the plant and equipment, raw materials, work in progress, stocks, debts owing and any investments made.
• The shop, fittings, stock, bank cash and goodwill are a retailer`s capital; these are business assets.

Capital owned

• This is the total amount that the business owes its owners.
• Capital owned is Assets less liabilities i.e.  Assets = Capital + Liabilities
• Loans, trade creditors, bank overdrafts are current liabilities These are external claims for payment; they can be presented at any time for early settlement.

Fixed capital

• This is the total of all assets acquired for use in the business; not for resale except on special situations as second hand items.
• Land, buildings, machines, fittings, furniture, vans are assets; they are worked to cause provision of profits.
• Depreciate, through wear and tear is illiquid capital, is not easily convertible into cash.

Current assets

• Stocks, debts, investments made, bank and cash balances are current assets.
• The composition of these current assets continually changes.  As stock falls, cash rises from the sales and vice versa.

Liquid capital

• Cash and bank balances, investments and debtors are liquid capital.
• These assets can be converted into cash without serious loss of value.
• Stocks are liquid assets whose prices have to be reduced in order to convert them into cash instantly.
• Businesses usually hold sales in order to obtain the liquid funds to restock with the new season’s lines.

Working capital

•  Is current assets less current liabilities.
• Meets day-to-day expenses of running a business.           .
•  Pays creditors when debts are due.
• Buys  stock for cash and benefits from cash discounts.

-      Working capital may be increased by:

• the introduction of more cash capital by the owners
• ploughing back profits to its trading
• selling some of the fixed assets e.g. vehicles

-      Working capital is reduced by:

• cash withdrawals for own use
• loss on trading
• purchase of fixed assets for cash

-      Working capital ratio is current assets divided by current liabilities:

• it shows the extent of a business financial stability
• a working capital ratio of  2:1 shows financial stability of a business

-       Working capital requirements differ variably according to the nature of the trade and complexity of the production process.

Profit

• Businesses buy and sell goods for profit.
• In the course of trading, expenses like wages, insurance, rent, phones and bad debts are incurred.
• Below is the Trading Account of Mudo for the period ending 30 June 20..:

Gross profit

Gross profit is the difference between the cost of goods sold and the proceeds from their sale i.e. gross profit = net sales – cost of goods sold.

Mr Mudo`s gross profit was                 $(20 000 – 16 000)

                                                             =     $4 000

The gross profit percentage % was  4 000 x 100
                                                             20 000

                                                            =     20%

• The gross profit percentage should lie above 20% and remain consistent from year to year.

Causes of decline in gross profit percentage

a) Cash losses

-     Staff might embezzle cash takings.

-     The cash figures will be reduced.

-     The gross profit and gross profit percentage will be reduced.

b) Stock losses

• Regular theft of small quantities of stock.
• Handing over of stock to friends or accomplices without paying for them.
• Unrecorded drawings in kind.
• Shoplifting.
• Breakages.
• Spoiling of perishables e.g. fruits, milk and vegetables.
• Poor storage, weevil and vermin destroy the stock. c)    Mark-downs on:
• slow moving stocks e.g. furniture
• seasonal goods e.g. raincoats
• shop soiled items, e.g. clothes
• obsolete or outdated items e.g. manual lawn mowers d)    Increased purchase price
• Retailers buy goods at increased prices and sell at low prices to compete for customers.
• Charging old lower prices instead of new higher prices. e)    Faulty stock valuation
• Overvalued opening stock inflates the cost of stock sold and lowers the gross profit percentage.
• Faulty stock taking shows a decline or rise in gross profit percentage. f)     Dishonesty and incompetence result in decline of gross profit percentage.

Ways to improve the gross profit percentage

• Buying in bulk at lower cost from suppliers.
• Buying for cash and enjoy cash discounts.
• Raising prices of items when the chance arises.
• Raising prices during festive seasons.
• Reducing prices of items less strongly demanded.
• Buying perishables and selling before expiry dates.
• Supervising trading closely.
• Disciplining observed dishonesty and incompetence.

Cost of goods sold

• This is the cost of actual goods that have been sold i.e. initial stock plus net purchases minus closing stock.

Net profit

• Net profit is gross profit less expenses.

•  Net Profit figures are critical to a business. It shows the actual return on the investment and assists the owner to plan ahead, obtain loans, expand or sell the venture.

• -Net profit figures are important for income tax purposes.

Rate of stock turn

• This is the number of times in a year the average stock can be moved or sold.
• This measures the speed at which stocks are cleared.
• Rate of stock turn is cost of goods sold divided by average stock at cost price.
• Average stock can be worked by adding initial stock and closing stock and dividing it by two; or by averaging the figures obtainable for stocks for the period.
• Mudo`s rate of stock turn  was 16 000

=    (4 000 + 3 000)
             16 000

              7 000

            =    2.3

• The rate of stock turn varies from trade to trade. Fruits, meats, milk which are perishables, have high rates of turnover. Furniture, cars, radios have low rates of turnover.
• A high rate of stock turn means less capital is tied up in stocks. Stocks move fast.

-      Rate of stock turn can be stabilised, maintained or increased by:

• reducing the size of the average stock needed to maintain a given expected volume of sales

• placing small orders with suppliers
• determining the tastes of prospective consumers through market research
• advertising
• organising sales promotions
• offering credit

Multiple choice questions

Use the following information to answer questions 9 to 11.

Dom Trader`s business transactions were:

The balance sheet of Dom Company as at 31December 201..

$                                                               $

Premises                              18 000          Capital                                 20 000

Furniture                                4 000          Loan                                    10 000

Stock                                      6 000          Creditors                                2 000

Debtors                                  3 000

Bank                                      1 000

32 000                                                       32 000

1. a) Calculate:

(i)   working capital

(ii) comment on the working capital

1. b) Explain how working capital can be increased.
2. Explain any five forms of capital.
3. Why might the gross profit percentage fall?
4. Explain fully the following:
   a) gross profit b)   net profit   c) cost of goods sold                              d)   expenses
5. a)   What is the rate of  stock turn?
6. b) Explain how to increase the rate of stock turn.
7. The capital of a business was $150 000 and the cost of goods sold was $90 000. The rate of    stock turn was five and the percentage of  gross profit over turnover was 20%.

a) Calculate the:

(i)   gross profit

(ii) average stock at selling price

7. Mod  Balance Sheet as at 31December 20..

$                                                                  $

a) Calculate:

(i)    fixed capital

(ii)  circulating capital (iii) capital employed (iv) working capital.

8. Use the following data to answer the questions that follow.

Purchases  $100 000

20%  gross profit as a percentage of turnover

Average stock $10 000

Expenses  $8 000 a)   Calculate:

(i)   turnover

(ii) gross profit

(iii) net profit

(iv) rate of stock turnover, and comment.