Professional Studies 3 (MEE3002)
Demand & Supply
Tutorial Solutions
1)
What is meant by the term Economics?
It is the allocation of scarce resources.
2)
Identify the three key players in an economy.
Households (people), Firms, Government
3)
Define using examples the concept of opportunity cost.
Opportunity cost is the next best alternative forgone.
Examples for each of these:
Government - £100m – build school or hospital – if building the school then the
hospital is forgone.
Engineering Company – Can install a new machine or upgrade computer system. If it
installs a new machine then the upgrade of the computer system is foregone.
Student - £10 to spend on Amazon Prime or go to the cinema – if student spends £10
on Amazon Prime they cannot go to the cinema.
4)
Identify the factors of production and their associated rewards.
Land = Rent
Labour = Wage
Capital = Interest
Enterprise = Profit
5)
What are the three questions that society must answer to allocate resources.
What should be produced? In what quantities?
How should production take place? How will resources be organised?
For whom should production take place? Who will receive the products?
6)
Using an example explain what is meant by the ‘Basic Economic Problem.’
The Basic Economic problem is based on scarcity, and an example is the commodity
of oil. Resources such as oil are a limited resource and our wants are unlimited.
Therefore we must make a choice, pay more for fuel or get public transport which will
take longer, leading to an opportunity cost.
7)
Identify the THREE types of Economics Systems and give an example of each.
Free Market – Hong Kong, Switzerland, New Zealand
Command – North Korea, Venezuela, Cuba
Mixed Economy – UK, France, Germany
8)
What is a Product Possibility Frontier (PPF) and what does it show?
A PPF shows the maximum potential output combinations of two goods an economy
can achieve when all it resources are fully and efficiently employed.
9)
Using diagrams show a PPF with
a)
Increasing costs of production
b)
Decreasing costs of production
c)
Constant costs of production.
10)
Using a PPF explain how economic growth is achieved.
11)
Identify on the diagram below which points are attainable / unattainable.
V, W, X, Y
12)
Identify FIVE factors which may produce economic growth, causing the PPF to shift
right.
(i)
(ii)
(iii)
Investment in physical capital
Investment in human capital
Investment in infrastructure
(iv)
(v)
(vi)
13)
Migration
Improvements in technology
Innovation and Invention of new products and additional resources.
What factors would cause the PPF to shift inwards to the left.
•
•
•
•
14)
Wars
Natural disasters
Recession
Land degradation
Define demand and define supply.
Demand is the quantity of a good that purchasers are willing and able to buy at a given
price over a given period of time - ceteris paribus.
Supply is the quantity of a good that producers are willing and able to supply at a given
price over a given period of time – ceteris paribus
15)
What is meant by the term “ceteris paribus”?
Ceteris paribus refers to all other things remaining constant
16)
Explain why the demand curve is downward sloping.
Income effect
When the price of a good decreases, you are able to buy the same amount for a lower
price
Substitution effect
When the price of a good falls, it becomes attractive relative to other similar/substitute
goods
17)
Explain why the supply curve is upward sloping.
Sellers are concerned about profits
If price is low, revenue is low → profits are low
There is little incentive to supply the good
Costs of production increase with output
The price of the good must at least cover the cost of production
The price therefore needs to rise with output if costs rise in this way
18)
Explain the difference between a movement along and shift of
a)
A demand curve
b)
A supply curve.
Movement:
Movement along is associated with a change in Price effecting quantity
demanded.
Shift:
Shift is caused by a change in any non-price factor, i.e. if income increase, then
demand will increase at each and every price (ceteris paribus).
19)
Identify the determinants of demand.
•
•
•
•
•
•
•
•
20)
Price
Population
Law
Advertising
Substitutes
Tastes
Income
Complements
Identify the determinants of supply.
•
•
•
•
•
•
•
Costs of production
Technology
Price of related goods
Expectations
Taxes
Subsidies
Weather
•
21)
Regulation
Explain, using a demand and supply diagram:
a)
Equilibrium price (D = S, no tendency to change )
b)
Shortage (D>S) = Excess Demand
c)
Surplus (S>D) = Excess Supply
Diagram:
22)
Outline the THREE functions of price.
• They ration goods and services
• They signal information to the market and about the market
• They provide incentives to actors in the market
23)
Explain the difference between productive and allocative efficiency.
• Productive efficiency: Produce maximum output for the lowest / minimum cost.
• Allocative efficiency: When there is an optimal distribution of goods and
services, taking into account consumer’s preferences.
Professional Studies 3 (MEE3002)
Cost Curve
Tutorial Solutions
1. Explain, with examples, the difference between FIXED and VARIABLE COSTS.
Fixed costs:
Are not related to output
Examples:
Rent; Business Rates; Depreciation; Insurance
Variable costs:
Are related to output
Examples:
Raw materials; Components; Staff wages; Electricity.
2. Define the Short Run and the Long Run.
The Short Run
The Short Run is that period of time in which at least one factor of production is
fixed. Technology is fixed.
The Long Run.
The Long Run is that period of time in which all factors of production are variable.
Technology is variable.
3. Table solutions:
Total costs
Average costs
Labour
TP
TFC
TVC
TC
AFC
AVC
ATC
MC
0
0
10
0
10
-
-
1
8
10
2
12
1.25
0.25
1.50
0.25
2
24
10
4
14
0.42
0.17
0.58
0.13
3
42
10
6
16
0.24
0.14
0.38
0.11
4
60
10
8
18
0.17
0.13
0.30
0.11
5
70
10
10
20
0.14
0.14
0.29
0.20
6
72
10
12
22
0.14
0.17
0.31
1.00
The above table shows the change in total product as more labour is added to production
and all other factors of production remain constant. The cost of the capital employed is
£10.00. The price of labour is £2.00 per unit of labour.
(Table populated above)
4. Label each of the average and marginal cost curves below on the diagram.
5. Mark on the appropriate diagram the points where both diminishing marginal returns
and diminishing average returns set in. (Mark on your diagram)
Remember:
Marginal curves always cut average curves at their turning points
Marginal costs exhibit diminishing returns before average costs
6. Explain the law of diminishing marginal returns.
Product
The law of diminishing marginal returns – if increasing quantities of a variable input
are combined with a fixed quantity of another input, eventually the marginal
product and then the average product of the variable input will decline.
Costs
The law of diminishing marginal returns – if increasing quantities of a variable input
are combined with a fixed quantity of another input, eventually the marginal cost
and then the average cost of the variable input will at first fall and then begin to
rise.
7. Outline the difference between the Short run and Long run Curves.
• They are both ‘U shaped….’
• S/R at least one factor is fixed (SRAC will fall and then begin to rise due to
Diminishing Returns by adding more variable factors to a fixed factor.
• L/R a company can choose scale of production, vary FOP and lower the LRAC,
to maximise profits.
• The LRAC curves are drawn on the assumption of given technology.
• It is a flatter shape than SRAC due to internal Economies of Scale /
Diseconomies of scale and the ability for the firm to vary technology used by
firms in a particular industry. Productive efficiency - optimal level of production
and Minimum Efficient point can be seen in the L/R
• The LRAC is said to be an envelope for the SRAC to contain them all.
Costs
SRAC1
SRAC2
LRAC
Output
8. Define the term Economy of Scale. Give some examples of Internal
Economies of Scale.
An economy of scale arises whenever average cost per unit falls in the long run
as output is increased. Internal Economies of Scale relates to the following
examples:
−
−
−
−
Purchasing economics - bulk buying
Managerial economies employing specialised staff to raise efficiency
Risk bearing economies arise from product diversification
Financial economies – lower interest rates on loans from larger firms
9. Define the term Diseconomy of Scale. Give some examples of Internal
Diseconomies of Scale.
A Diseconomy of Scale arises whenever average cost per unit increases in
the long run as output expands.
−
−
−
Managerial factors – Lack of control and mismanagement of staff.
Communication – poor communication leading to poor decision making
Morale: Working in a highly specialized assembly line can be very boring,
therefore workers become demotivated / alienated.
10. Explain the difference between Internal and External Economies of Scale.
Internal Economy of Scale relates to the individual firm.
External Economy of Scale relates to the industry.
11. Give examples of an External Economy and Diseconomy of scale.
External Economy of Scale:
-
Subsidy for renewable energy companies – reduces cost of production for
the whole industry.
External Diseconomy of Scale relates to the industry.
-
Trade Tariff on steel import – increase costs of production with the price of
imports for production increasing.
Professional Studies 3 (MEE3002)
Market Structure and Macroeconomics
Tutorial Solutions
Market Structures
1)
According to the classical model of economics, what is the position where firms want
to maximise profit.
Marginal Cost = Marginal Revenue
2)
List some alternatives to Profit Maximisation.
Revenue maximisation, sales maximisation, survival, ethical etc.,
3)
List the FIVE different Market Structures that exist.
Perfect Competition, Monopoly, Monopolistic Competition, Oligopoly, Duopoly
4)
Define the term MONOPOLY and list some characteristics. Give ONE example from
the Private and Public sectors.
Monopoly in its purest form is when one firm dominates the industry. Its characteristics
are:
-
Single / sole supplier
Barriers to entry
Firm and industry will be synonymous
No close substitutes
The ability to earn abnormal profits in the long run
Public Sector Monopoly:
NI Railways
Private Sector Monopoly:
Gillette razor blades
Google (90% market share in web search in the UK)
5)
Define the term MONOPOLISTIC competition. Give some examples of industries in
the UK today.
Monopolistic competition is imperfect competition amongst the MANY.
Examples:
Coffee Shops
NI Estate Agents
Hairdressing Salons
Taxi Companies
6)
What is a DUOPOLY? Give an example.
Duopoly refers to a market where two firms dominate
Examples:
Pepsi Cola / Coca Cola
Boeing / Airbus
7)
Define the term OLIGOPOLY and list some characteristics. Give some examples of
industries today in the UK which could be described as oligopolistic.
A market dominated by a few large firms i.e. “competition amongst the few,” and are
best defined by the conduct (or behaviour) of firms within a market.
Its characteristics are:
-
A market dominated by a few large firms
Barriers to entry and exit
Interdependence
Non price competition
Price rigidity
Examples:
8)
Banks; Petrol Retailers; Mobile Phone Providers; Supermarkets
Define PRICE DISCRIMINATION and list the conditions needed for it to occur.
Price discrimination is when a business charges different consumers different prices
for the same goods or service.
Conditions:
Degree of monopoly power
Separating of markets
Elasticity of demand is different in the markets
No seepage from one market to another
9)
Give examples of PRICE DISCRIMATION by:
a) Time of Day
Early bird menus; off-peak travel cards
b) Time of Year
Airline flights; travel by sea; holidays
c) Age
Rail cards; Travel by bus; Car insurance
d) Gender
Car insurance
10)
Discuss the costs and benefits of a monopoly.
This needs to be discussed with examples in a paragraph format:
Costs of a Monopoly:
Monopoly restricts output and increases price (consumers pay a higher price)
Restricts choice and exploits consumer welfare (limits availability)
Productive and Allocative inefficiency (X-inefficient) (Not producing at minimum cost)
May suffer from diseconomies of scale (too big and inefficient)
Benefits of a Monopoly:
Economies of Scale benefits – reinvest (Use profits to provide other services)
May be in a contestable market – competition evident (Apple enable the consumer to
benefit from choice through competition)
Dynamic efficiency gains – changes over time (better use of technology)
Creative Destruction (according to economist Joseph Schumpeter when old industries
and firms are no longer profitable, they close down enabling the resources (capital and
labour) to move into more productive processes i.e., Creative destruction means that
the company closures and job losses are good for the long-term well-being of the
economy
Marcoeconomics
11)
Distinguish between MACRO and MICRO Economics
Microeconomics is the study of individual markets within an economy, e.g. labour;
housing; transport
Macroeconomics is the study of the economy as a whole e.g. employment and
unemployment; inflation; interest rate
12)
List the FOUR main Economic Indicators
Economic Growth, Employment, Inflation and Balance of Payments.
13)
What others are considered by the UK Economy
Environment and Living Standards.
Explain what is meant by the term ‘recession’ and outline the key characteristics.
14)
A decline in GDP for two or more successive quarters (negative growth)
•
•
•
•
•
•
•
•
Falling demand for UK goods
Rising unemployment & falling Living Standards
Falling government tax receipts
Increased government borrowing and debt
Sharp fall in business confidence and Investment
Falling prices (Deflation)
Fall in demand for imports
Lower interest rates form central banks
Explain what is meant by the term ‘boom’ and outline the key characteristics.
15)
A period of rapid economic expansion resulting in higher GDP
•
•
•
•
•
•
•
16)
Actual Growth is above the trend of 2.5%
Danger of Inflation as the economy overheats
Strong and rising levels of consumer spending
Growth in employment, and Labour may experience an increase in wages
More demand for imported goods
Increased demand for houses and therefore house price inflation
Increased company profits
Define ‘Inflation’ and state the indicator used to measure this.
Inflation is the rate of change of the price level in an economy
Indicator: CPIH
17)
The UK Economy has been in a ‘trade deficit’ for a long period, can you explain why
this has occurred?
Due to factors such as globalisation and dependence on Imports > Exports.
18)
What is the circular flow of income?
Circular Flow of Income shows that money circulates within an economy, indicating the
flow of goods and services and factors of production between firms and households.
19)
List 3 injections. Define an injection
An injection is that which adds to the circular flow of income.
Three injections:
Government Expenditure (G)
Exports (X)
Investments (I)
20)
Define a leakage. List 3 leakages
A leakage is a withdrawal from the circular flow of income.
Three leakages:
Savings (S)
Imports (M)
Taxation (T)
21)
Income is a flow concept, explain:
Income is a flow concept i.e. the money an individual earns in a year, wages or salary
per week/month. It is measured over a period of time.
22)
Wealth is a stock concept, explain:
Wealth is a stock concept i.e. the total value of an individual’s assets at a moment in
time. It is measured at a point in time i.e. on specific assets the person holds.
23)
Briefly outline the 3 methods by which National Income can be calculated
National Income is calculated by the:
- Income Method
- Output Method
- Expenditure Method
In theory each of these three methods should be equal in value [Y≡O≡E]
24)
Define the standard of living
The standard of living can be calculated by using: Real GDP per capita.
25)
Give 3 limitations to GDP figures
Three limitations of GDP figures:
- Distribution of income is not considered
- The Hidden Economy is excluded
- Social costs are not included
26)
Give 3 social indicators of the standard of living
Three social indicators of the standard of living are:
- Crime rates
- Divorce rates
- Work/life balance
27)
How are national figures used?
National Income figures are used:
- To measure the standard of living
- To measure economic growth
- To determine government policy
- To predict future trends
- To calculate contribution to EU, IMF, World Bank
28)
How is economic growth measured?
Economic growth is measured by calculating the growth in real Gross Domestic
Product over a specified period of time. Can be shown graphically by a shift of the
PPF outwards.
Professional Studies 3 (MEE3002)
Economic Growth & Productivity
Tutorial Solutions
1)
Explain what Aggregate Demand (AD) is and the main components.
Total demand for a country’s goods and services at a given price level
AD = C + I + G + (X-M)
Components: Consumption, Investment, Government Spending, and Exports minus
Imports.
2)
Define what is meant by the ‘multiplier effect’ and give an example.
The multiplier effect refers to the increase in final income arising from any new
injection of spending.
It can be positive or negative
For example, if a business builds a factory, it will employ construction workers and
their suppliers as well as those who work in the factory.
3)
List and explain FOUR factors that contribute to Economic Growth
Stability in AD and government policy – Use of Monetary, Fiscal or Supply Side
High levels of investment – to encourage increase in productive potential
Technological progress – improve the productivity
High quality education and training – increase human capital skills
Good export performance – create inflows and encourage trade
Strong manufacturing and services sectors – provide jobs and competitiveness
A low level of international debt – less risk
Manageable changes in population – various policies for sustainable growth.
4)
Explain the difference between Economic Growth and Economic Development.
Economic growth:
A measure of the value of output of goods and services within a time period
Economic Development:
A measure of the welfare of humans in a society
5)
List TWO other measures of Economic Growth.
HDI – Human Development Index (measure of longevity, knowledge and standard of
living.)
PPP – Purchasing Power Parity (is a theory which suggests that exchange rates are in
equilibrium when they have the same purchasing power in different countries. This
means that the statistics take into account the actual cost of living.
6)
Explain different ways in which the Government can encourage Economic Growth?
Government spending – Investment should directed towards economic infrastructure,
education & training, etc.
Rate of interest – there is a negative correlation between interest rates and economic
growth. High interest rates reduce investment as the cost of borrowing funds is high
and profitability is lower. Also, consumer spending will be lower, so then investment is
further discouraged.
Overseas trade – positive correlation between export growth and economic growth
Worker productivity – education and training - dynamic and mobile workforce will
contribute to growth.
Tax rates – Growth may be encouraged by higher/better tax incentives for business.
High levels of investment – needs to be appropriate and long-term in areas such as
product innovation and new technologies.
7)
Discuss the costs and benefits of Economic Growth.
Benefits:
A general improvement in living standards
Rising Employment
The accelerator effect of growth
Business confidence
The fiscal dividend to government
Potential environmental benefits
Costs:
Inflation risks
The environment
Inequalities of income and wealth
Regional disparities
Resource depletion
** Be able to write in paragraph format with detail.
8)
What is meant by Monetary Policy?
Refers to changes in:
Interest rates
Supply of money
Exchange rates
……… to influence the economy
9)
What is present interest base rate? Who sets it?
0.75% and it is set by the MPC (Monetary Policy Committee)
10)
What is the difference between expansionary and contractionary Monetary Policy.
Expansionary is the lowering of interest rates to increase AD and growth
Contractionary is the increasing of interest rates to lower AD and growth.
11)
Explain what is meant by Fiscal Policy?
Fiscal policy involves a deliberate attempt to influence macroeconomic objectives by
using government expenditure and taxation to influence the level of total demand in
the economy.
12)
List 4 areas of Government Expenditure.
Provide goods and services such as health, education, defence, welfare payments.
To provide benefits to people, so that income and wealth can be redistributed from rich
to poor
Infrastructure projects such as roads, bridges, railways and communication systems.
13)
What is a Budget Deficit/Surplus?
G > T (Government spending > Taxation: usually in a recession
T > G (Taxation > Government Spending: usually in a boom.
14)
What is the difference between DIRECT and INDIRECT Taxes?
Direct taxes are taxes on income, profits and wealth, paid directly by the bearer to the
tax authorities. (Income Tax)
Indirect taxes are taxes on expenditure (e.g. VAT). They are paid to the tax authorities,
not by the consumer, but indirectly by the suppliers of the goods or services
15)
Explain
(a) Progressive Tax - rate of income taken in taxes rises as income rises e.g. income
tax
(b) Regressive Tax - one where the rate of tax falls as income rises e.g. council tax
(c) Proportional Tax - rate is constant regardless of income
(d) Corporation Tax - rate of tax increase as company profits increase
16)
What is meant by Productivity? Why is it important?
Measures how much output is produced for a given input e.g. for an hour of work.
17)
Outline 4 determinants of International Competitiveness.
Unit labour costs – labour cost per unit of output
Quantity and quality of skills of a nation’s workers
Labour flexibility
Economic stability
Tax regimes – boost competitiveness in the market for factors of production
Degree of regulation
Rates of innovation
18)
What is Globalisation?
Globalisation is international integration. It can be described as the process by which
people of the world are unified into a single society. The process is a combination of
economic, technological, socio-economic and political forces.
19)
Explain 4 drivers of Globalisation.
Improved communication – ICT
Reduced transport costs – containerisation and logistics
Trade liberalisation – free movement of goods, services & capital
Increased competitiveness in manufactured goods – driven by developing countries
Rise in skills levels throughout the world – moving operation to developing countries
20)
Examine the consequences of Globalisation.
The changing nature of international trade – emerging markets and deindustrialisation.
Forcing firms to think globally – ease of business
Increasing foreign direct investment – attracting FDI
Increasing the susceptibility of countries to external crisis e.g. Financial Crisis
Increasing the roles of international organisations such as the WTO and IMF
Reducing price difference between countries - transparency
Changing countries competitive advantage – China v America Trade War
Externalities – rise of environmental pollution.
The rich get richer and the poor get poorer – Income inequality
21)
Outline the arguments for and against the UK leaving the EU, and how it has impacted
NI?
For:
Control immigration – ensure jobs are available for current citizens
Make Britain great again – Be independent and regain UK Sovereignty
Reject the Brussels bureaucrats – democracy in making decision (remove finance
contributions to EU)
Reject what the establishment wants – UK rules for trade
Lower prices – enabled by trade policies.
Against:
Impact on the Economy – diminished growth and unemployment
Avoid scary uncertainty – business decisions and suppliers
A more secure world – trade as one unity
Keep that easy access to EU – Access to Single Market and Customs Union.
A hit to households (income) – Holding off on spending due to expectations.
Students are expected to show their understanding of the withdrawal agreement, that it
allow frictionless trade, but there are complications with the sea border to GB and the
impact this has had on food retail etc.,
22)
Outline the key aspects of the Withdrawal Agreement in terms of the NI Protocol?
The maintenance of the Common Travel Area between Ireland and the UK.
Regulatory alignment on agricultural products and industrial goods (note that this does
not extend to services).
NI should benefit from both membership of the EU’s Customs Union and membership
of the UK’s Customs territory.
NI should remain part of the UK VAT area but EU VAT rules concerning goods will
continue to apply in NI.
An all-island Single Electricity Market will be maintained.
NB: The above elements of the Withdrawal Agreement are designed to achieve
frictionless trade on the island of Ireland and maintain North-South cooperation
Professional Studies 3 (MEE3002)
Introduction to Financial & Management Accounting
Summary Tutorial Solutions
1. Explain the difference between ‘unincorporated’ and ‘incorporated’ business entities.
The business entities of Sole Trader and Partnership are described as unincorporated and are
simple structures with basic government reporting requirements. The owners and their
businesses are one and the same legal identity. This results in owner’s personal liability for any
business debt or liabilities incurred.
Limited Companies, both private and public, are described as incorporated. This means the
owners and their businesses are separated by separate legal identity. The business, and not the
owner(s) is a legal identity in its own right and is now called a Company. The ‘business’ is
responsible for any debt or liabilities incurred and not the owners. Government reporting
requirements are more stringent.
2. Explain the significance of ‘limited liability’ to business owners.
Shareholders can only lose the amount of money they invested into the Company and cannot be
held personally responsible for Company debt or liabilities.
In other words, the shareholder’s liability is limited to the amount of their investment.
3. Explain both the benefits and drawbacks of a limited company.
Benefits
•
•
•
•
Limited liability
Can appoint directors
Spread of ownership easy
Transfer of ownership easy
Drawbacks
•
Legal requirements - professional advice required - audit
•
•
Extra administration and costs
Accounts must be filed – public access
4. Briefly discuss the key purposes of financial accounting.
The Companies Act (1985) places a legal obligation on companies to provide final accounts that
are audited and ‘true and fair’
•
•
•
•
Provide information for stakeholders; customers, shareholders, suppliers etc.
Provide the opportunity for the business to monitor its own activities
Provide transparency to enable the firm to attract investment
Reduce the chance for fraud – although not 100% successful!
5. Outline the key differences between financial and management accounting.
Financial Accounting
The preparation of company accounts from business records
•
•
Geared toward external users of accounting information
Concerned with past performance
Management Accounting
The preparation of financial statements, reports and data for use by managers
•
•
Aimed at internal users of accounting information
Concerned with the future
6. Identify 2 ‘internal users’ of financial accounts and 2 ‘external users’ and explain why each user
is interested in this data.
Internal Users
•
•
•
Management
• Recording
• Analysis and Evaluation
• Control
• Decision making
Employees
Owners
External Users
•
•
•
Legal Requirements - Tax authorities, Auditors, Registrar of Companies
Performance & Stability Requirements - Bankers, Suppliers, Competitors, Local
Community, Media, Investors/Shareholders
Statistical Requirements - Government
7. Define the Accounting Equation components.
Assets minus Liabilities = Capital
Assets
•
•
Non-current Assets – those lasting more than one year and not used up in
production – equipment, machinery, buildings, etc.
Current Assets – assets used up during production and which will realise (convert to)
cash within a year – debtors (receivables), raw materials, stock (inventory), etc.
Liabilities
The amounts owed to trade payables (creditors), tax liability, interest owing, bank loans, loans
from other businesses.
•
•
Current liabilities – those obligations the entity has to meet within a year (pay in
cash/bank)
Non-current liabilities – those obligations the entity has to meet after twelve months
Capital
•
•
•
Business owner(s) may introduce capital at start-up stage or as business develops
Businesses must have capital in order to purchase assets and maintain their
operations
Business capital usually comes in two main forms: debt and equity
8. Explain the purpose of the ‘Balance Sheet’ and describe its components.
•
•
•
•
•
A snapshot of the firm’s value / worth at a specific point in time
Lists assets, liabilities, and capital of the business - shows what a company owns
(assets) and what it owes (liabilities)
Shows the assets a company has (use of funds) and where the money came from to
acquire those assets (source of funds)
A guide to the level of gearing (the ratio of loan to share capital) - will be explained in
Ratio Analysis topic.
A guide as to the degree of working capital
9. Explain the purpose of the ‘Income Statement’ and describe its components.
•
•
•
Shows the flow of sales (turnover or revenue) and the associated business costs over
a time period
Shows the level of profit or loss made
Shows what has been done with the profit or loss – where allocated to
10. Briefly discuss the limitations of financial accounting.
Financial accounts focus on quantitative data only – there is no qualitative information.
The state of the market is not illustrated, in that, accounts reflect on what has happened in the
past but no business environment will remain static – it is historic data.
The accounts do not inform on any of the following examples:
•
•
•
•
•
•
Quality of the workforce
Quality of the business’s technology
Market share
New product success
Arrival of a new competitor
Loss of a valued supplier
Jackson Engineering Ltd
Income Statement for the year ending 30 April 2015
Sales
Less Cost of goods sold
Opening inventory
Add Purchases
Less Closing inventory
18,614
3,776
11,570
(4,000)
(11,346)
Gross Profit
Less Expenses
Salaries
Motor expenses
Rent
Sundry expenses
7,268
2,447
664
576
1,202
(4,889)
Operating profit
2,379
Balance Sheet at 30 April 2015
Non-current assets
Equipment
Motor vehicles
600
3,400
4,000
Current assets
Inventory
Accounts receivable
Cash at bank
Cash in hand
4,000
4,577
3,876
120
12,573
Less Current liabilities
Accounts payable
3,045
(3,045)
Net Assets
13,528
Capital account
Opening capital balance
Add Operating profit
11,149
2,379
Capital
13,528
Clearwater Engineering Ltd
Income Statement for the year ending 30 June 2016
Sales
Less Cost of goods sold
Opening inventory
Add Purchases
Less Closing inventory
32,344
5,442
14,326
(2,500)
(17,268)
Gross Profit
Less Expenses:
Salaries
Insurance
Telephone
Fuel
15,076
3,506
850
1,200
1,560
(7,116)
Operating profit
7,960
Balance Sheet at 30 June 2016
Non-current assets
Machinery
Motor vehicles
1,856
5,100
6,956
Current assets
Inventory
Accounts receivable
Cash at bank
Cash in hand
2,500
3,141
5,476
450
11,567
Less Current liabilities
Accounts payable
2,031
(2,031)
Net Assets
Capital account
Opening capital balance
Add Operating profit
Capital
16,492
8,532
7,960
16,492
Professional Studies 3 (MEE3002)
Ratio Analysis
Tutorial Solutions
1. The following financial data has been extracted from the financial statements of Global
Engineering plc:
Simplified Income Statement at 23/2/2020
£m
Sales
47,298
Cost of goods sold
43,668
Gross Profit
3,630
Expenses / Overheads
1,500
Operating Profit (profit before interest & tax)
2,130
Simplified Balance Sheet 23/2/2020
Non-current Assets
Current Assets
Current Liabilities
Net Current Assets / Working capital
Long-term Loans
£m
23,864
6,300
10,263
?
7,999
Net Assets
11,902
Total Capital / Equity / Shareholders’ Funds
11,902
a) Use the simplified accounts shown above to calculate the following ratios:
i)
Profitability
2 ratios (1 to be ROCE)
Gross Profit
= Gross Profit / Sales
= 3630 / 47,298 x 100
= 7.67%
Operating Profit = Operating Profit / Sales
= 2130 / 47,298 * 100
= 4.50%
ROCE
= Operating Profit / Capital Employed
= 2130 / 19,901 x 100
= 10.70%
where:
Capital Employed
ii) Liquidity
Current Ratio
= Long-term Loans + Shareholders Funds
= 7999 + 11,902
= 19,901
2 ratios
= Current Assets / Current Liabilities
= 6300 / 10,263
= 0.61:1 (expressed as a ratio)
N.B. Cannot do Acid Test Ratio as you do not have value of Inventory/Stock
iii) Efficiency
1 ratio
Asset Turnover = Sales / Net Assets
= 47,298/11,902
= 3.97 times
N.B. Cannot do Receivables Days or Inventory Turnover as you do not have
values for Receivables or Inventory
iv) Gearing
Gearing
1 ratio
= Long Term Liabilities / Capital Employed
= 7999 / 19,901 x 100
= 40.19%
b) From an accounting perspective, use your calculated ratios and other information
drawn from the simplified accounts to discuss the possible success of Global
Engineering in the future.
c) How much working capital does Global Engineering have as at 23/2/2020?
Working capital
= Current Assets - Current Liabilities
= 6300 - 10,263
= (3,963)
2. The following is an extract from the Annual Report and Accounts of Deep-Sea
Engineering PLC for the financial year ended 2020:
Simplified Income Statement
2020
£’000
Sales
7811
Gross Profit
5994
Operating Profit (profit before interest & tax)
1638
Interest +
308
Profit before tax
1946
Corporation tax
389
Profit after tax
1557
Dividends
695
Final Profit / Earnings for the year
862
Simplified Balance Sheet
2020
£’000
Non-current Assets
Inventory
Trade Receivables
Cash
Trade Payables
Net Current Assets / Working Capital
13,695
278
3114
205
5899
?
Long-term Loans
2412
Net Assets
8981
Share Capital
6491
Profit & Loss Reserves / Retained Earnings
2490
Total Capital / Equity / Shareholders’ Funds
8981
a) Use the simplified accounts shown above to calculate the following ratios for 2020
i) Profitability
Gross Profit
2 ratios (1 to be ROCE)
= Gross profit / Sales
= 5994 / 7811 x 100
= 76.74%
Operating Profit = Operating Profit / Sales
= 1638 / 7811 x 100
= 20.97%
ROCE
= Operating Profit / Capital Employed
= 1638/11393 x 100
= 14.38%
where:
Capital employed
ii) Liquidity
Current Ratio
= Long-term Loans + Shareholders Funds
= 2412 + 8981
= 11393
2 ratios
= Current Assets / Current Liabilities
= (278 + 3114 + 205) / 5899
= 0.61:1 (expressed as a ratio)
Acid Test ratio = (Current Assets – Inventory) / Current Liabilities
= ((278 + 3114 + 205) - 278) / 5899
= 0.56:1 (expressed as a ratio)
iii) Efficiency
1 ratio
Asset Turnover = Sales / Net Assets
= 7811 / 8981
= 0.87 times
Receivable Days
= Trade Receivables / Sales x 365
= 3114 / 7811 x 365
= 145.5 days
Inventory Turnover
= Cost of Goods Sold / Inventory
= 1817 / 278
= 6.54 times
where:
Cost of Goods Sold
= Sales - Gross Profit
= 7811 – 5994
= 1817
iv) Gearing
1 ratio
Gearing = Long Term Liabilities / Capital Employed x 100
= 2412 / 11393 x 100
= 21.17%
b) From an accounting perspective, use your calculated ratios from each of the four
analysis areas to comment upon Deep Sea Engineering’s financial position for the
period ended 2020 with reference to: Profitability; Gearing; Liquidity; Efficiency.
c) Define ‘gearing’ and explain the significance of this ratio in financial analysis.
Refer to answer in Q3.
d) How much working capital does Deep-Sea Engineering have for the financial year
ended 2020?
Working capital
= Current Assets - Current Liabilities
= 3597 – 5899
= (2302)
3. Construction Industry Solutions PLC has been established for 12 years and the following
financial data is provided for the financial year ended 2019.
Simplified Profit and Loss Account
2019
£’000
Sales Revenue
5688
Gross Profit
4970
Operating Profit (Profit before interest & tax)
1499
Interest (+)
169
Profit before tax
1668
Corporation tax
334
Profit after tax
1334
Simplified Balance Sheet
2019
£’000
Non-current Assets
9600
Inventory
128
Trade Receivables
2511
Cash
98
Trade Payables
3813
Net Current Assets / Working Capital
?
Long-term Loans (-)
2635
Net Assets
5889
Shareholder Funds
4682
Reserves / Retained Earnings
1207
Total Equity
5889
a) Use the simplified accounts shown above to calculate the following ratios for 2019
i) Profitability
Gross Profit
2 ratios (1 to be ROCE)
= Gross profit / Sales
= 4970 / 5688 x 100
= 87.3%
Operating Profit = Operating Profit / Sales
= 1499 / 5688 x 100
= 26.4%
ROCE
= Operating Profit / Capital Employed
= 1499 / 8524 x 100
= 17.6%
where:
Capital employed
ii) Liquidity
Current Ratio
= Long-term Loans + Shareholders Funds + Reserves
= 2635 + 4682 + 1207
= 8524
2 ratios
= Current Assets / Current Liabilities
= (128 + 2511 + 98) / 3813
= 0.72:1 (expressed as a ratio)
Acid Test ratio = (Current Assets – Inventory) / Current Liabilities
= ((128 + 2511 + 98) - 128) / 3813
= 0.68:1 (expressed as a ratio)
iii) Efficiency
1 ratio
Asset Turnover = Sales / Net Assets
= 5688 / 5889
= 0.97 times
Debtor Days
= Debtors / Sales x 365
= 2511 / 5688 x 365
= 161.1 days
Inventory Turnover
= Cost of Goods Sold / Inventory
= 718 / 128
= 5.61 times
where:
Cost of Goods Sold
iv) Gearing
Gearing
= Sales - Gross Profit
= 5688 – 4970
= 718
1 ratio
= Long Term Liabilities / Capital Employed x 100
= 2635/8524 * 100
= 30.9%
b) From an accounting perspective, use your calculated ratios from each of the four
analysis areas to comment upon Construction Industry Solutions’ financial position
for the period ended 2019.
c) Explain the significance of the financial relationship between loan capital and share
capital.
Gearing is the relationship between the loan capital and the share capital of a
business. A company is said to be high geared if it has a large proportion of loan
capital to share capital >50%.
A low-geared company has a relatively small amount of loan capital <50%.
If a business is high-geared, it may be reluctant to raise even more finance by
borrowing as the cost of the loan capital monthly repayments to the lender will
increase and the business needs to have the cash to meet these repayments.
Whereas share capital does not need to be repaid to the shareholder; the business
only then needs adequate cash to pay any shareholder dividends.
Highly geared businesses will struggle to acquire additional loans as the lender will
then exercise caution in granting increased borrowing levels due to increasing
repayments.
A low gearing level could be a weakness if the economy were expanding rapidly.
Company management teams could be judged as timid as the companies are not
able to benefit from rapid growth. An increased gearing level could bring the reward
of having extra money available for expansion which would mean increased profits
– higher dividends and the loan can be repaid gradually. If the money has been
raised through shareholders, and if the investment is successful there will be
increased profits and potentially higher dividends for shareholders.
d) How much working capital does Construction Industry have for the financial year
ended 2019?
Working capital
= Current Assets - Current Liabilities
= 2737 – 3813
= (1076)
Professional Studies 3 (MEE3002)
Finance and Working Capital
Tutorial Solutions
1. Outline two internal sources of finance.
Retained profits/earnings
Profit after tax that has not been returned to the owners. It is the single most important
source of finance for a business. Around 65% of all business funding comes from
retained profits.
Sale of assets (buildings or machinery)
It makes good business sense to dispose of under-used assets. If the asset is still
needed, it may be possible to sell it but immediately lease it back (sale & leaseback).
Reduction in working capital
e.g., Reducing stocks or operating a tighter credit control policy. This is a very shortterm solution since the company needs to have sufficient working capital to run its dayto-day operations.
2. Outline two external sources of finance
Bank Overdrafts (to assist cash flow)
Long-term Bank Loans (loan capital)
Mortgages / Debentures (specialist loan capital)
Hire purchase and Leasing
Supplier credit (trade payables)
Debt factoring / Invoice discounting
Issue Share Capital (sell share of business – share / equity capital)
Venture Capital / Business Angels (capital investment specialists – take a share of the
business – private equity capital)
Government assistance – industry/sectoral (subsidy or grant-aid)
3. Compare and contrast 3 external sources of finance.
Compare and contrast 3 of the above external sources at Number 2 in more detail.
Further detail contained on PDF slides.
4. Explain how ‘supplier credit’ can be used as a source of finance.
The business can agree 30-, 60- or 90-days credit terms with suppliers. Typically, 30
days terms from date of invoice. This is only available with Business-to-Business
trading, where each extend credit terms to each other. This frees up cash flow/working
capital for other requirements such as paying workers’ wages or electricity expenses.
Supplier can charge an interest penalty if their invoice is not paid within agreed credit
period. Supplier may stop supply of goods / raw materials if account not maintained.
5. Compare and contrast the main ways corporations raise external finance.
Long-term Bank Loans (loan capital) – see video on Slide 17.
Loans (debt) must be repaid each month + interest cost. Banks do not get ownership of
the business.
Issue Share Capital (equity capital) – see Slide 18 + video.
Company sells shares of the company on the stock exchange to the public. Share
capital is not repaid since the shareholder buyers get ownership of the company to the
value of/number of shares purchased. Company needs to pay a dividend to the
shareholders from company profits.
6. Describe the role venture capital companies play in assisting businesses to raise capital.
A venture capital company (VC) brings investment capital into a company. The VC
favours larger amounts of investment (£millions) and fund high growth research /
innovations (short-medium term payback). The VC will take a percentage share of the
business relative to the amount of investment. The VC plays an active role in the
management of the company and then floats the company on the stock exchange at the
most financially opportune time. The VC then sells their shares to enable the return of
their capital plus a lucrative capital gain. Crescent Capital is an example of a VC
company in Belfast.
7. Explain how revenue expenditure differs to capital expenditure.
Revenue Expenditure
Short-term finance refers to money required to finance activities for a short period (less
than one year) - used to manage the day-to-day operations of a business (working
capital)
Capital Expenditure
Long-term finance refers to money required to finance activities for a long period (1 year
- 10+ years) Normally used for financing new businesses and for expansion of existing
businesses
8. Outline three factors a business should take into consideration when choosing a source
of finance?
•
•
•
•
•
•
•
Cost - £££
Use of funds – purpose – working capital / capital
Status and size of business (sole trader/partnership/limited company)
Stage of development, e.g., start-up business
Financial situation, e.g., financially secure
State of economy
Gearing level
9. Many businesses can find themselves operating with a shortage of working capital for a
variety of reasons. Outline three reasons why businesses have working capital problems?
•
•
•
•
•
•
•
Poor control of trade receivables
Overstocking and understocking of inventory
Overtrading – not enough cash to support production/sales
Over borrowing – possible rising interest payments
Downturns in demand / seasonal demand
Externalities – economic conditions such as recession
Unexpected events – natural disaster
10. Explain four ways in which businesses can improve cash flow?
•
•
•
•
•
•
•
•
•
•
Use of bank overdraft facilities
Negotiate additional short-/long-term loans
Sell off or reduce inventory
Sell off unwanted / unnecessary non-current assets
Use of sale and leaseback
Stimulate cash sales
Target overdue trade receivables
Only make essential purchases
Delay payments or extend credit (time to pay) with selected suppliers
Introduce new capital