Financial Information and Decisions — CIE IGCSE Business Studies Revision Notes

What you'll learn

• Why businesses need finance, and how the reason determines which source is appropriate
• The full range of internal and external sources, short-term and long-term
• How to build and interpret a cash flow forecast, and why cash is not profit
• How to read an income statement and a statement of financial position
• The profitability and liquidity ratios, how to calculate them and what each reveals
• Who uses published accounts and what each user is looking for
• How to approach the calculation and evaluation questions this topic attracts

Key terms and definitions

Start-up capital — the money needed to set a business up before it earns anything.

Working capital — the money available for day-to-day running, calculated as current assets minus current liabilities.

Capital expenditure — spending on non-current assets that will be used over several years, such as machinery.

Revenue expenditure — spending on day-to-day running costs such as wages, rent and raw materials.

Internal finance — money raised from within the business or its owners.

External finance — money raised from outside sources.

Liquidity — how easily assets can be turned into cash to pay debts as they fall due.

Cash flow forecast — a prediction of money coming in and going out over a future period.

Net cash flow — total inflows minus total outflows in a period.

Gross profit — revenue minus the cost of sales, before other expenses.

Profit for the year — what remains after every expense has been deducted.

Non-current asset — an item kept and used for more than a year.

Current liability — a debt due within a year.

Core concepts

Why a business needs finance

The reason for needing money determines which source is suitable, so exam answers should always begin here.

Starting up requires capital before any revenue exists — premises, equipment, initial stock.

Expansion requires larger sums over a long period: new premises, additional machinery, entering a new market.

Day-to-day operation requires working capital to bridge the gap between paying suppliers and being paid by customers.

Replacing assets requires finance when equipment wears out, and this is predictable enough to be planned for.

Surviving a cash shortage requires short-term finance quickly, and this is the situation in which businesses accept the most expensive terms.

The rule examiners reward: match the length of the finance to the length of the need. Borrowing long-term for a short-term cash gap means paying interest for years; using an overdraft to buy premises means repaying on demand money you cannot free up.

Internal sources

Retained profit — profit kept in the business rather than paid to owners. No interest, no repayment and no loss of control, but only available to a business that has traded profitably, and spending it means owners receive less.

Sale of assets — converting unused equipment or property into cash. Useful for genuinely surplus items; damaging if the business sells something it still needs.

Owner's savings — the simplest source for a sole trader or partnership. No interest, but the owner's personal money is now at risk.

Reducing working capital — chasing debtors harder or holding less stock. Frees cash but risks losing customers or running out of goods.

External sources

Bank loan — a fixed sum repaid over an agreed period with interest. Predictable and suitable for large purchases, but requires security and the interest is a cost whatever happens.

Bank overdraft — permission to go into a negative balance. Flexible and ideal for short-term gaps, but interest rates are high and the bank can demand repayment at any time.

Trade credit — buying from suppliers now and paying later, typically in 30 to 90 days. Effectively free, but taking too long damages supplier relationships and may cost discounts.

Hire purchase — paying for an asset in instalments, owning it at the end. Spreads the cost but works out dearer overall.

Leasing — renting an asset rather than buying it. No large initial outlay and maintenance is often included, but the business never owns the item and pays indefinitely.

Share issue — selling shares, available only to limited companies. Raises large sums with no repayment, but dilutes ownership and control and commits the company to paying dividends.

Debentures — long-term loans from investors, repaid with interest on a fixed date.

Venture capital — investment in a high-potential business in exchange for a stake, usually with involvement in decisions.

Government grants — money that need not be repaid, usually conditional on location, industry or job creation.

Micro-finance — small loans to entrepreneurs without access to conventional banking, significant in developing economies.

Crowdfunding — many small contributions raised online, which also tests demand for the product.

Factoring — selling unpaid invoices to a finance company for immediate cash at a discount.

What determines the choice

A strong evaluation answer weighs several of these rather than listing sources:

• Amount needed — a share issue for a large sum, trade credit for a small one
• Purpose and duration — long-term finance for long-term assets
• Cost — interest rates, fees, the discount lost through factoring
• Legal form — only limited companies can issue shares
• Existing borrowing — a heavily indebted business struggles to borrow more
• Control — owners who want to keep control avoid shares and venture capital
• Speed — an overdraft is arranged in days, a share issue takes months
• Risk and security — lenders require assets as security

Cash flow and why it is not profit

A cash flow forecast sets out expected inflows and outflows month by month:

Net cash flow = total inflows − total outflows Closing balance = opening balance + net cash flow

The closing balance of one month becomes the opening balance of the next, so a single error propagates through the whole forecast.

Cash and profit are different things, and this distinction is examined repeatedly. A business can be profitable and still fail, because:

• Credit sales are counted as revenue immediately but the cash arrives weeks later
• Buying a non-current asset drains cash without being an expense in that year
• Loan repayments reduce cash but only the interest portion is an expense
• Depreciation reduces profit without any cash leaving the business at all

The consequence is blunt: a business that runs out of cash cannot pay wages or suppliers and may fail even while trading profitably. Cash flow problems are the most common cause of small business failure.

Improving cash flow means bringing money in sooner or delaying payment out: chase debtors, offer discounts for early payment, negotiate longer credit from suppliers, lease rather than buy, or arrange an overdraft. Each has a cost — offering a discount reduces revenue, delaying supplier payment strains relationships.

The financial statements

The income statement shows performance over a period:

Revenue − cost of sales = gross profit Gross profit − expenses = profit for the year

The statement of financial position shows the position at a single date, and is built on the accounting equation: assets = liabilities + capital. It lists non-current assets, current assets, current liabilities, non-current liabilities and capital.

Ratio analysis

Profitability ratios

Gross profit margin = gross profit ÷ revenue × 100. Measures the mark-up achieved on goods before other costs. A fall means selling prices dropped or purchase costs rose.

Profit margin = profit for the year ÷ revenue × 100. Measures profit after all costs. If this falls while the gross margin holds, the problem is expenses rather than pricing.

Return on capital employed = profit ÷ capital employed × 100. Measures how efficiently the money invested is being used, and allows comparison with the return available elsewhere.

Liquidity ratios

Current ratio = current assets ÷ current liabilities. A result between roughly 1.5 and 2 is usually considered comfortable. Too low risks being unable to pay debts; too high suggests cash or stock sitting idle.

Acid test = (current assets − inventory) ÷ current liabilities. Stricter, because inventory may not sell quickly. A result near 1 is generally healthy.

Limitations. Ratios compare only what is measured. They ignore staff quality, reputation, market conditions and the state of the economy; they rely on historical figures; and they are only meaningful against the same business over time or against another business in the same industry.

Users of accounts

User	What they want to know
Managers	Performance, and where to act
Owners and shareholders	Return on their investment, dividend prospects
Employees	Job security, scope for pay rises
Banks and lenders	Whether the business can repay
Suppliers	Whether to offer trade credit
Customers	Whether the business will continue to supply
Government	Tax due, and compliance

Worked examples

Example 1: Completing a cash flow forecast

A business opens the month with $5,000. Inflows are $18,000 and outflows $20,000. Calculate the net cash flow and closing balance, and comment.

Net cash flow = $18,000 − $20,000 = −$2,000 Closing balance = $5,000 + (−$2,000) = $3,000

The balance is still positive, but the business spent more than it received. If the pattern continues the balance falls below zero within two months, so it needs either to increase inflows, delay outflows, or arrange an overdraft before that point. Noting when the problem arrives, rather than just that it exists, is what earns the analysis mark.

Example 2: Profitability ratios

Revenue $120,000; cost of sales $72,000; expenses $30,000; capital employed $150,000.

Gross profit = $120,000 − $72,000 = $48,000 Gross profit margin = 48,000 ÷ 120,000 × 100 = 40%

Profit for the year = $48,000 − $30,000 = $18,000 Profit margin = 18,000 ÷ 120,000 × 100 = 15%

ROCE = 18,000 ÷ 150,000 × 100 = 12%

The gap between 40% and 15% is the expenses. If last year's gross margin was also 40% but the profit margin was higher, the issue is rising overheads, not pricing — and that is where the business should look.

Example 3: Liquidity

Current assets $36,000, of which inventory is $15,000. Current liabilities $24,000.

Current ratio = 36,000 ÷ 24,000 = 1.5 Acid test = (36,000 − 15,000) ÷ 24,000 = 21,000 ÷ 24,000 = 0.875

The current ratio looks acceptable, but the acid test is below 1, which means that without selling inventory the business cannot cover its short-term debts. Since a large share of its current assets is stock, its liquidity depends on how quickly that stock sells. Comparing the two ratios, rather than quoting one, is what distinguishes a strong answer.

Example 4: Choosing a source of finance

A sole trader running a bakery needs $4,000 to replace an oven that has failed. Recommend a source of finance.

Start by classifying the need: this is a non-current asset, so the finance should be long-term, and it is urgent, so speed matters.

Share issue is impossible — a sole trader has no shares to sell.

Retained profit is ideal if available, costing nothing and risking nothing, but a small bakery may not hold $4,000 in reserve.

Bank loan spreads the cost over the oven's life and the repayments are predictable, though interest is payable and the bank will want security.

Hire purchase or leasing avoids a large outlay and the oven can be in place quickly. Leasing means never owning it; hire purchase costs more overall but ends in ownership.

Overdraft would be wrong — short-term finance for a long-term asset, at a high rate, repayable on demand.

A supported recommendation: hire purchase, because the oven is essential to trading and must be replaced immediately, the cost is spread over the period the asset is used, and the business ends up owning it. If the bakery has sufficient retained profit, that would be cheaper still.

Note the shape of the answer — classify the need, rule options out with reasons, then choose one and justify it against this business.

Common mistakes and how to avoid them

Treating cash and profit as the same thing. They are the most commonly confused pair in this topic and the distinction is examined directly.

Listing sources of finance without judging them. An evaluation question wants a recommendation with reasons tied to the business in the case study.

Ignoring the business's legal form. Only limited companies can issue shares. Recommending a share issue to a sole trader loses the mark immediately.

Calculating a ratio and stopping. The number earns one mark; explaining what it means for this business earns the rest.

Carrying an error through a cash flow forecast. Each closing balance becomes the next opening balance, so check the first month before completing the rest.

Assuming a higher current ratio is always better. A very high ratio means resources sitting idle.

Forgetting the limitations of ratios. Almost every evaluation question expects them mentioned.

Exam technique for Financial Information and Decisions

This topic carries more calculation than any other in the syllabus, and calculations are the easiest marks on the paper if handled methodically.

Show your working, always. A wrong final figure with correct method still scores; a bare wrong number scores nothing.

Include units and the percentage sign. A ratio without units is an incomplete answer.

Use the case study's own figures and context. Generic answers about "a business" cap out quickly; the marks are in applying the point to the business described.

Answer the command word. Calculate wants a number and working. Explain wants a reason. Analyse wants consequences. Evaluate wants a judgement with both sides and a supported recommendation.

For evaluation, always give a recommendation. Weigh two or three options, choose one, and justify the choice with something specific about the business.

Check the reasonableness of a figure. A gross profit margin above 100% or a negative closing balance where you expected a positive one signals an arithmetic slip worth thirty seconds to find.

Quick revision summary

• Match the length of the finance to the length of the need — this single rule answers most source-selection questions
• Internal: retained profit, sale of assets, owner's savings. External: loans, overdrafts, trade credit, hire purchase, leasing, shares, debentures, venture capital, grants, micro-finance, crowdfunding, factoring
• Only limited companies can issue shares
• Net cash flow = inflows − outflows; closing balance = opening balance + net cash flow, carried into the next month
• Cash is not profit — credit sales, asset purchases, loan repayments and depreciation all break the link
• Gross profit margin = gross profit ÷ revenue × 100; profit margin uses profit for the year; ROCE = profit ÷ capital employed × 100
• Current ratio = current assets ÷ current liabilities, comfortable around 1.5 to 2
• Acid test removes inventory; near 1 is healthy
• A falling profit margin with a steady gross margin means expenses, not pricing
• Ratios ignore staff, reputation and market conditions, and are only meaningful compared over time or within an industry